One of the fundamental forces portfolio investors should be aware of is the tug of war between concept and valuation. Put a different way, between what growth prospects are for a company and the price we have to pay to own a piece of those prospects in the current market.

This question is important because loong history says that prices are determined as much by the hopes and fears of investors as by the objective characteristics of the company profits/profit growth we’re ultimately buying and selling. These emotions, which often feed on themselves, can vary from euphoria to depression.

To my mind, it’s like being in a sailboat sailing across the Atlantic (the fact that I don’t know anything about sailing doesn’t bother me, or matter here). Weather conditions–sunny skies or hurricane–can make a big difference in how you set your sails.

Warren Buffett recently observed that the ratio of the market cap of the S&P 500 to the current level of US GDP is unusually high–higher in fact than at the peak of the internet bubble of 1999-2000. I interpret this as saying that a gigantic storm is on the horizon. It’s just a question of when and how hard it hits.

According to news reports I’ve read (my quick search hasn’t unearthed a transcript) right after this Elon Musk asked Cathie Wood, owner of ARKInvest, what she thought. Her reply was that GDP underestimates US economic growth and, implicitly, that Buffett doesn’t get this. There’s a certain irony here since Buffett’s claim to a place in the American investor Hall of Fame is his understanding, way ahead of everyone else, that conventional accounting statements understate the value of companies with intangible assets like brand names and superior distribution networks.

As far as I can tell, the link between the market cap/GDP ratio and Buffett comes from a 1999 speech in which he describes it as a powerful indicator.

I encountered the idea for the first time–no Buffett name attached to it–in the mid 1980s, as investors and academics tried to come to grips with the apparent overvaluation of the Tokyo stock market. As an explanation, market cap/GDP only worked if you pretended that Europe didn’t exist. Yes, the Japanese market was trading at~2x GDP while the US traded at, say, .8x–these figures are at least directionally correct. That reinforced the idea, which led to terrible investment decisions for a half-decade, that Japan was expensive while the US was cheap. But during the same period, the German stock market was trading at 0.2X GDP, and going nowhere, despite strong GDP growth. The UK market, on the other hand, had a market cap well in excess of all of Continental Europe combined, even though its economy represented barely a fifth of the EU total. So even in the same economic bloc, UK stocks were crazy expensive while their German counterparts were dirt cheap.

Although the industry studiously ignored EU counterexamples to the simple market cap/GDP theory, it seems to me that both the UK and Germany were particularly instructive. In the case of London, most of the market cap represented foreign profits that derived from the UK’s former colonial empire. In Germany, it was (and remains) a question of investor preference: companies preferred to remain private and get the capital they needed from banks; investors had (have) a much greater desire for fixed income than stocks.

Back to the here and now.

At least half the revenues of the S&P 500 come from abroad. I think a much greater percentage of the revenue growth of the S&P comes from its non-domestic exposure. I suspect the foreign percentages for the NASDAQ are considerably higher still. So, in my view, what was a somewhat useful simplification 35 years ago probably doesn’t have much relevance today. That doesn’t mean stocks are cheap or that a storm isn’t on the way, just that market cap/GDP isn’t a great indicator.

What little I get from Cathie Wood’s response is that she seems to believe that the souls of mature iconic American companies are being eaten by insiders’ financial engineering that prioritizes current profits over future growth. Arguably, this will be exposed during the next economic downturn and that, therefore, such firms will not have the defensive characteristics that their size and (lower) PEs might suggest. Think: Intel.