Warren Buffett's favorite market gauge hit a 2-year high, signaling stocks are heavily overvalued and could crash (2024)
Warren Buffett's favorite market gauge has surged to a two-year high of 184%, signaling stocks are overvalued and could suffer a devastating crash.
The "Buffett Indicator" takes the combined market capitalization of all actively traded US stocks and divides that figure by the latest quarterly estimate for gross domestic product (GDP). Investors use it to compare the overall value of the stock market to the size of the national economy.
The FT Wilshire 5000 index has jumped 9% to a record high this year, boosting its market capitalization to about $51.47 trillion, according to Wilshire Indexes.
US GDP is up 40% from its pandemic low to $27.94 trillion last quarter. Dividing the first figure by the second gives a reading of 184%.
Buffett proclaimed in a Fortune article in 2001 that his namesake yardstick was "probably the best single measure of where valuations stand at any given moment."
Berkshire Hathaway's CEO said that stocks would likely be fairly valued at a reading of 100%, and they'd be approaching bargain territory at 70% or 80%. But he warned it would be "playing with fire" to buy them near the 200% mark.
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The legendary investor added that when the indicator soared to a then-record high during the dot-com bubble, it should have been a "very strong warning signal" that a crash was coming.
Stocks have zoomed to record highs this year, prompting several commentators to ring the bubble alarm.
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The furious rally has been fueled by immense excitement around AI-related stocks like Nvidia and Microsoft, and mounting hopes on Wall Street that the Federal Reserve will slash interest rates and the economy will escape a recession this year.
Buffett's yardstick proved its worth at the start of 2022 when it flashed red by surging past 200%. The S&P 500 and tech-heavy Nasdaq Composite plunged 19% and 33% respectively within the next 12 months.
It's worth noting the gauge is far from perfect, however. It compares the stock market's current value to a growth reading for the previous quarter.
It also relies on GDP, which excludes overseas income, whereas US stocks price in the value of companies' domestic and international operations.
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Yet the metric's return to the lofty levels that preceded past market disasters is a clear red flag for some experts.
Both John Hussman, president of Hussman Investment Trust, and Paul Dietrich, B. Riley Wealth Management's chief investment strategist, have pointed to the indicator's surge as evidence of a bubble that might end with a painful pop.
Warren Buffett's go-to market gauge surged to a two-year high of 184%. The "Buffett Indicator" compares the stock market's total value to the overall size of the economy. Buffett has warned that buying stocks at a reading near 200% is "playing with fire."
Berkshire Hathaway's cash position has reached a new high. It sold a portion of its largest holding, Apple, to buy U.S. Treasury Bills. And Warren Buffet has all but told us at the Berkshire Hathaway Annual Meeting in Omaha that the market is overly expensive and unattractive.
Based on the latest S&P 500 monthly data, the market is OVERVALUED somewhere in the range of 92% to 154%, depending on the indicator, up from last month's 89% to 149%.
In Warren Buffet's annual letter to Berkshire Hathaway investors, Buffett compared today's stock market to a casino, with investors buying and selling rapidly in the hopes of winning big. “For whatever reasons, markets now exhibit far more casino-like behavior than they did when I was young,” he wrote.
Being caught in a value trap, by which an investor might incur considerable losses. The requirement of market proficiency to determine whether a stock is overvalued or not.
The "Buffett Indicator" takes the combined market capitalization of all actively traded US stocks and divides that figure by the latest quarterly estimate for gross domestic product (GDP). Investors use it to compare the overall value of the stock market to the size of the national economy.
In our 2Q 2024 Quarterly US Market Outlook, we noted that at the end of March 2024, our price/fair value metric for the US market was 1.03. At a 3% premium, the market had not officially entered overvalued territory, yet we noted that it was definitely feeling stretched.
As of 2024-05-31 12:00:00 AM CDT (updates daily): The Stock Market is Significantly Overvalued according to Buffett Indicator. Based on the historical ratio of total market cap over GDP (currently at 187.1%), it is likely to return 0.4% a year from this level of valuation, including dividends.
Warren Buffett's stock purchases in the most recent quarter include Chubb Limited (CB) and Occidental Petroleum (OXY). HP Inc. (HPQ) and Paramount Global (PARA) are among Warren Buffett's stock sales in the most recent quarter. The Berkshire Hathaway portfolio includes 41 stocks as of May 2024, including Apple Inc.
With its 4-star rating, we believe Berkshire Hathaway's stock is undervalued compared with our long-term fair value estimate of $427 per Class B share, which is equivalent to 1.45 times our estimate of the firm's book value per share at the end of 2024 and 1.35 times for 2025.
That mark was much higher than it was after the roaring 20s, much higher than it was before the Financial Crisis in 2007, and higher than it was before the Dot-Com Bubble burst in 2000. Today, the S&P Composite sits at 154% above the trend line! The stock market is definitely overvalued from a historical perspective.
The Buffett Indicator expresses the value of the US stock market in terms of the size of the US economy. If the stock market value is growing much faster than the actual economy, then it may be in a bubble.
Warren Buffett wrote “Common yardsticks such as dividend yield, the ratio of price to earnings or to book value, and even growth rates have nothing to do with valuation except to the extent they provide clues to the amount and timing of cash flows into and from the business.”
The S&P 500 is now 20% overvalued based on calculations comparing the stock market with the bond market, says Jack Ablin, chief investment officer at Cresset Capital Management.
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