Buffett Indicator had warned of stock market bubble waiting to burst (2024)

Just when Nifty bulls were celebrating the 25,000 milestone, bears got high on a co*cktail of bad news from all over the world and gatecrashed the party. But if a 2,600-point fall in Sensex caught you off-guard on Monday morning, you probably missed an early warning signal from the Buffett Indicator which had shot past an extremely high peak of 150%.

While Nifty PE of 24 times was in sync with the valuation observed in most parts of the last 10 years of the Modi government, Buffett Indicator, which measures India's market capitalisation-to-GDP, showed that equity market claims on the real economy at excessively high levels.

Even the Economic Survey had last month warned that it could be a harbinger of market instability rather than market resilience.

According to legendary investor Warren Buffett, the percentage of total market cap relative to GDP is probably the best single measure of where valuations stand at any given moment. While anything above 100-level is often treated as expensive, 150 is unusually high.

At such extreme valuation levels, markets start behaving like a gas-filled balloon waiting to burst at the slightest prick.

"At such valuations, five-year returns are likely to be subpar (< 5% CAGR) with risk of large drawdowns. Decelerating earnings and weakening US labour market (recession risks?) suggest an inflection point could be near," says Nuvama's Prateek Parekh.

Even the BEER ratio, a metric used to evaluate the relationship between bond yields and earnings yield, suggests that the stock market is slightly more expensive than the bond market at current levels.

As current valuations offer a limited scope for further expansion, it all boils down to earnings and the June quarter earnings season hardly gave any trigger on the upside.

Motilal said its Nifty EPS estimate for FY25 was cut by 1.2% to Rs 1,120, largely owing to Reliance Industries and BPCL.

"FY26E EPS was also reduced by 0.8% to Rs 1,319 (from Rs 1,330) as upgrades in Infosys, Coal India, Tata Motors, and Maruti were offset by downgrades in Axis Bank, HDFC Bank, ICICI Bank, and IndusInd Bank," the brokerage said.

As geopolitical tensions, recession fears in the US following disappointing economic data and the unwinding of Japanese Yen carry trade, dampened the market mood globally, the combined m-cap of all BSE-listed stocks declined by Rs 17 lakh crore to Rs 440 lakh crore.

Sensex and Nifty slipped below their Budget-day lows while fear gauge index India VIX jumped over 60% in its biggest single-day surge since 2015.

Market advisor Sandip Sabharwal opined that another 7-10% drop will remove froth and make the market valuations reasonable and in tune with long-term averages.

"Investors should be waiting to invest afresh because I believe that corrections will not end in one day. A lot of people, who have been seeing the market rise continuously after one-day fall, think that the fall is over and we should invest afresh. I think this is a time to be a bit patient," he said.

This sell-off, however, is more of a short-term volatility by way of profit booking and is no indicator of any long term panic mode, analysts say.

For investors looking at entering the equity market, a staggered entry during volatile periods can be considered, said Tanvi Kanchan of Anand Rathi.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)