Elon Musk asked Cathie Wood about the Buffett indicator flashing red. The Ark Invest chief explained why she isn't worried.
- Elon Musk asked Cathie Wood about the Buffett indicator's record readings.
- The Ark Invest CEO criticized GDP as a measure and trumpeted innovation.
- Warren Buffett's favorite market gauge surged before the dot-com crash.
- See more stories on Insider's business page.
Elon Musk asked Cathie Wood this week what she thought about Warren Buffett's favorite market indicator flashing red recently. The star stock-picker replied that the gauge was likely inaccurate and argued that the heady valuations of certain technology stocks were justified.
"What do you think of the unusually high ratio of S&P market cap to GDP?" the Tesla chief asked the Ark Invest boss. He was referring to a version of the Buffett indicator, which takes the combined market capitalization of a country's publicly traded stocks and divides it by the latest quarterly GDP figure available.
The S&P 500 represents about 78% of the total market cap of US stocks, as measured by the Wilshire 5000 Total Market Index. The S&P 500's combined market cap has surged past $33 trillion this year, more than 150% of the latest estimate for fourth-quarter US GDP of $21.5 trillion.
Wood replied to Musk's question by suggesting that GDP understates economic growth because it doesn't fully account for increased productivity. Technological innovations today are "dwarfing" those in previous eras, driving down prices and fueling demand, she said.
The Ark founder also drew a line between the dot-com bubble and the current hype around tech stocks.
"Back then, investors chased the dream before the tech was ready and while costs were too high," she said, adding that "after gestating for 20-30 years, the dream has turned into reality."
Wood predicted that companies that have failed to innovate and instead have borrowed money to fund stock buybacks and dividends would "pay a steep price." She expects them to be forced to cut prices to shift inventory and make debt repayments.
In short, Wood's view is that the disconnect between the S&P 500's market capitalization and national GDP isn't worrying because GDP is a flawed measure, unprecedented innovation justifies higher company valuations, and technological advances are cutting costs so inflation won't be a problem either.
Her stance clashes with Buffett's praise of his namesake gauge in a Fortune article in 2001 as "probably the best single measure of where valuations stand at any given moment." When the indicator peaked during the dot-com boom, it should have been a "very strong warning signal" of a crash, the Berkshire Hathaway CEO wrote.
Musk might have to wait a few more months to find out which investor is right.