Warren Buffett's favorite market indicator soars to record high, signaling stocks are overvalued and a crash may be comingFebruary 10, 2021
Bill Pugliano / Getty
- Warren Buffett’s preferred market gauge hit a record high of 195%, signaling a crash could be coming.
- The “Buffett indicator” compares the value of the stock market to the size of the economy.
- The investor praised it as “probably the best single measure” of overall stock valuations.
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Warren Buffett’s favorite market indicator surged to a record high of 195% on Tuesday, signaling stocks are overvalued and could tumble in the coming months.
The “Buffett indicator” takes the combined market capitalization of all publicly traded stocks in the US, and divides it by quarterly gross domestic product. Investors use it to gauge the stock market’s valuation relative to the size of the economy.
The Wilshire 5000 Total Market Index jumped to $41.8 trillion on Tuesday, while the advance estimate for fourth-quarter GDP is $21.5 trillion.
Dividing those numbers puts the Buffett indicator at 195% – well above the 187% level it reached in the second quarter of 2020, when GDP was about 10% lower.
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Buffett praised his namesake gauge in a Fortune magazine article in 2001, calling it “probably the best single measure of where valuations stand at any given moment.”
The billionaire investor and Berkshire Hathaway CEO added that when the indicator hit a record high during the dot-com bubble, that should have been a “very strong warning signal” of the crash to come.
Buffett’s preferred yardstick also soared in the months before the financial crisis, making it a reliable tool in anticipating market downturns.
However, the measure has its flaws. For example, it compares the current value of stocks to the previous quarter’s GDP. Moreover, US-listed companies don’t always contribute to the American economy, and GDP ignores overseas income.
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The COVID-19 pandemic has also disrupted economic activity and depressed GDP, inflating the Buffett indicator’s readings over the past year. Still, stocks are expensive by almost any measure, suggesting the gauge isn’t completely off the mark.
Here’s the St. Louis Federal Reserve’s version of the Buffett indicator (both market cap and GDP are indexed to the fourth quarter of 2007):