How does "Buffet Indicator" work when market cap(nominator) is daily & GDP(denominator) is quarterly?

Question

Simple question about "Buffet Indicator", but more like a question regarding the economic indicators in general.

Buffet Indicator = mkt cap / GDP

But as stated in the title, the market cap has daily frequency whereas GDP has at least quarterly frequency. This means that until the next quarter's GDP is announced, all daily market cap will be divided by the very same GDP announced before and on the date when the new GDP is announced in the end of the quarter, suddenly the denominator changes dramatically.

I feel like this kind of different frequency can cause big spikes on the bordering date, i.e: whenever the new GDP is announced.

Thus, a simple forward fill doesn't seem like a good idea. How do some indicators that mix up frequencies like Buffet Indicator stay relevant despite this flaw?

Answer 1

It is generally true that indicators constructed that way (higher frequency on top) can and do jump when GDP (or another lower frequency denominator) is released. This can be an issue in some use cases, so these indicators are not perfect, but in they are still useful in many cases.

A few points:

• The more volatile the numerator is relative to the denominator, the less it matters. Try to pick the months of GDP releases in the chart below.

• It can be useful for the big picture: for example if the "Buffet indicator" falls from 250% to 247.5% because GDP was just reported to have grown by 1%, has the big picture fundamentally changed?

• It's useful for static or short-term (within the quarter) analysis, because the denominator doesn't change.

• Even in dynamic analysis it can be useful, despite the jumps, especially for comparison purposes, because all the items share the same denominator.

• In ratio indicators such as the "Buffet indicator" or credit impulse (new credit over GDP), numerator and denominator are related, so the higher frequency one should adjust when new data pertaining to the lower frequency one is released. For example, is yesterday's market valuation still still justified given that today's GDP shows a drop of 1%? If not, it will probably correct downward.

• You can always make the indicator perfectly consistent by taking the average of the higher frequency numerator over the frequency of the denominator. This would be a much better indicator per se, but obviously not for daily monitoring.