Interpreting the Wilshire 5000-to-GDP Ratio and Its Scaling
Article Quant Q&A · Author: user3138766
Summary
The document explains why a Wilshire 5000-to-GDP series built from normalized index values can still be compared over time, and why it should not automatically be read as a literal ratio of market capitalization in dollars to GDP in dollars. The Wilshire series discussed is an index rather than a direct monetary valuation, so its scale and construction matter. To form a meaningful ratio, the component series must be made comparable, either by expressing them in consistent monetary units or by normalizing them to a common base.
The answer argues that changing the common scale changes the numerical level but preserves the broad time-series picture, particularly when both series have similar values at the chosen base date. It relates the measure to a price-to-sales ratio and discusses its popular interpretation as a Buffett-style market valuation indicator. The indicator is described as a crude measure that offers limited insight in isolation; the choice of GDP versus GNP and index variant is said to have little practical effect on the broad picture. The source does not establish a precise valuation signal or forecasting use.
Key ideas
- A ratio requires component series to be on comparable scales or in consistent units.
- Normalizing two series to a common base changes the displayed level but can preserve their relative movement over time.
- A market-index value is not necessarily equivalent to the dollar market capitalization of its constituents.
- The Wilshire-to-output ratio is often interpreted like a broad market price-to-sales measure.
- The indicator is a rough contextual measure and does not provide a valuation or forecasting rule by itself.
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# Wilshire 5000/GDP Ratio dividing indexed values and not actual values?
# Wilshire 5000/GDP Ratio dividing indexed values and not actual values?
I’ve been playing around with the FRED datasets: Wilshire 5000 Total Market Full Cap, and nominal US GDP.
I found that the Wilshire 5000/GDP index (https://fred.stlouisfed.org/graph/?g=qLC) is the quotient of two adjusted datasets: Wilshire 5000 Total Market Full Cap (Q4 2007 = 100), and nominal US GDP (Q4 2007 = 100).
The Wilshire/GDP ratio is commonly referred to as the “ratio of total value of US equities to GDP.” This is clearly not what the ratio is measuring, though. It is measuring the ratio of growth rates from the same base year, Q4 2007.
Why is FRED dividing the growths and not the actual values?
## Answer by AKdemy (score 3)
https://quant.stackexchange.com/a/65812
Both original datasets are not normalized to `Q4 2007`; Wilshire 5000 Total Market Full Cap Index WILL5000INDFC and GDP. However, `Total Market Full Cap` would imply a value far above 214. On a side remark, there are a bunch of Wilshire indices. It is simply done to make it comparable and once you have the same units, the ratio will always result in the same outcome (it does not matter if actual USD, or millions, or billions - as long as both are treated equally, you can also normalize them to 100 at some date - outcome is always the same).
In my opinion, the more commonly looked at is this one. The reason is that its base is the December 31, 1980 capitalization of USD 1,404.596 billion (so the value on that date is 1,404.569. Therefore, the index is an excellent approximation of dollar changes in the U.S. equity market. For instance, values of 2157.146 on December 30, 1985, and 2164.690 on December 31, 1985, represent an approximate increase of USD 7.5 billion. More details can be found on FT Wilshire 5000 Index Family.
The one used by FRED starts with a value of 1. Ignoring all details, this value is obviously not the market cap of 5000 companies. (Stock) Index construction is more difficult than most laymen expect (price indices even more so).
Dividing a value of ~100-200 by something that went from ~1.500 Billion to 20.000 billion over the same time is not particularly meaningful. Since you asked why FRED is not doing that, did you try that? I presume that would have answered your question.
The interpretation of the ratio is similar to the Price-Sales Ratio which is usually total market capitalization (the number of outstanding shares multiplied by the share price) divided by the company's total sales. $$P/S \ Ratio = \frac{Market\ Cap}{Sales}$$If the value is below 1, the investor is paying less for each unit of sales (or more if above 1).
Think of the US as a giant corporation. Total Market Cap is Wilshire 5000 and GDP is by definition all final goods and services. However, neither of these two series refers to the actual monetary value in USD. So there is a need to make them comparable:
- turn them into actual USD
- normalize them
Whatever you chose, it will give you the same picture (albeit with different numbers). I could not find quickly what the actual value at the beginning of the Wilshire index used by FRED was (potentially a sign that my claim that the other one is more common is reliable). Since I already defined W5000 as being in billions, I know it is easily comparable to GDP. I simply use that as a lazy proxy. Charting both Wilshire indices (normalized to be 1 at the end) shows that they are very similar in magnitude indeed.
Now we have two series that are in billions.
This looks (coincidence though) very similar to the last value that FRED displays. How come? Looking at the value of both series in `Q4 2007` shows that the two series are almost identical at this time.
If you now divide the value in Q4 2007 by itself and multiply by 100, you get 100 for each series. Either way, the ratio in that period will be 1 (or close to). I suspect that may have been a reason for the choice of `Q4 2007` as the base year but I do not have time to look up the reason at the moment. The entire history is therefore very similar. That depends on the choice of the base year, but overall it does not matter much (it is just the value that changes). All that matters is that you can compare it over time.
The next chart shows both Wilshire normalized as above, but now in comparison to the original value used in FRED's computation.
Last but not least, one can also "re-scale" with any value. Below is the Buffett Indicator (it seems to go back to an interview Warren Buffett gave to Fortune Magazine) in its original, and scaled by the value of the Wilshire index in `Q4 2007`.
The only difference is scale. I suppose the choice of FRED is the more natural one as it makes it more closely related to the Price-Sales Ratio interpretation.
Edit In terms of the "true" Buffett indicator, he actually used GNP and not GDP in his Fortune interview. It all really does not matter though. I have shown above that both Wilshire indices are almost identical. GNP and GDP is also very similar. Yes you can write, and some certainly have written, a PHD thesis on GDP vs GNP and computational differences, benefits and drawdowns and what not but it all does not matter here.
It is a kind of crude measure that is not saying much in isolation but gives you an idea of what on average happens. If that value is now 2 or 2.3 really does not matter at all. I cannot find an official link with a chart apart from some semi dodgy pdf sites but this is the original chart.
When you read the article, I think he never actually disclosed what he used. He simply states: "The chart shows the market value of all publicly traded securities as a percentage of the country's business--that is, as a percentage of GNP"
Between the two Wilshire alternatives discussed here, using the choice of FRED seems more reasonable for the task as this series also contains market capitalization that includes shares of stock not considered available to "ordinary" investors. However, it really (as shown above) makes no practical difference in terms of it usefulness as the "Buffett indicator".Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.