I had Claude create a chart of the Buffet Indicator, which is the ratio of the market value of stocks to GDP. Measured as a percentage of GDP, the stock market value was 157 percent in 2019, before COVID. It is 220 percent now.
Let me inflict a little bit of algebra on you. Let Y be GDP. Let E be corporate earnings. Let P be stock market value. Then the Buffet Indicator is P/Y, and
P/Y = (P/E)(E/Y).
E/Y is the share of corporate profits in GDP. It goes up when capital income increases relative to other sources of income. This ratio roughly doubled, from 8 percent to 16 percent, between 1995 and 2024. And as of 2024, the Buffet Ratio was almost exactly double what it was in 1995. So all of the increase could be explained by capital increasing its share of income.
But in early 2025, the profit share seems to have plummeted. Meanwhile, the Buffet Ratio continued to increase. So the stock market gains this year come from a big increase in P/E, the price-earnings ratio. One can call that the Great Repricing.
Possible explanations for the Great Repricing:
The Commerce Department data on corporate profits could be misleading. Wall Street could be looking at different data, showing robust profits.
Wall Street accepts that a decline in the profit share took place, but it sees the corporate profit decline as a blip. It expects capital income to come back strongly, especially as AI is used to reduce labor costs.
Stock prices are uncoupled from reality. The money from 401(k) plans continues to flow in. We have not had a long-term bear market since the 1970s, so people have lost any notion that stock market investment is risky.
Stock market valuations are part of what the WSJ calls the two-speed economy.
For high earners and many older Americans, the economy looks robust. They are still spending like gangbusters, and their 401(k) accounts and homes have soared in value. They nabbed 3% mortgages when rates were low. Some might worry about AI eventually coming for their jobs, but for now their positions look relatively secure.
For many others, momentum has stalled or reversed. The big wage growth experienced by low-income workers during the pandemic has petered out. Those workers are curbing their spending and in some cases are struggling to find jobs. Unemployment for Black Americans and many young people has jumped. Home prices and rents have risen sharply, making housing increasingly unaffordable.
The stock market is not the only phenomenon separating the haves from the have-nots.
For Camelia Kuhnen, a finance professor at the University of North Carolina at Chapel Hill, much of today’s divide relates to homeownership. Older and more prosperous households that owned homes before the pandemic are sitting on real estate that is now 50% more valuable, she said, citing the S&P CoreLogic Case-Shiller National Home Price Index.
“I think the U.S. population is split into these two types—the lucky ones, the asset owners, and the unlucky ones,” Kuhnen said. The latter “are now stuck because there’s no way they can come up with that down payment to buy a home.”
But if stock prices were to collapse, wealthy people could not afford to bid up home prices, so those would drop.
In the background of all of this, there is the unsustainable deficit spending of the U.S. government. Maybe there will be a lot of inflation, and that will validate the high prices for corporate shares and for houses.
Or maybe there will be a more abrupt debt crisis.
Since it seems impossible to limit or reform entitlement spending, and any politically feasible sufficient tax increases would likely tank the economy, the only alternative is continued and growing monetization of the debt, i.e., inflation. Instead of a dubiously "normal" 2% CPI inflation, we are likely to more regularly see 3% plus. Just hope that it doesn't accelerate into hyperinflation.
It'll be inflation. If the debt crisis looks like it's coming first, they'll monetize and inflate to the extent necessary to calm the panic. If the inflation comes first, it'll ward off the debt crisis.
I'm familiar with the extensive debates about whether inflation is a valid and well-defined concept, whether the choices made to produce official government numbers make sense, etc. But I've got to say, on a purely anecdotal and visceral level, I have never felt the reported figures to be as out of touch with my personal experience of reality as I do right now.