Warren Buffett's favorite market gauge is reading nearly 150%, signaling US stocks are still overvalued and at risk of tumbling further

warren buffett's favorite market gauge is reading nearly 150%, signaling us stocks are still overvalued and at risk of tumbling further

Warren Buffett. REUTERS/Rick Wilking

  • Warren Buffett’s go-to market gauge is reading nearly 150%, suggesting stocks remain overvalued.
  • The “Buffett indicator” has retreated from over 210% in January due to the stock-market downturn.
  • The metric compares the US stock market’s total value with the size of the economy.

Warren Buffett’s favorite market gauge is reading nearly 150%, signaling that beaten-down US stocks remain overvalued and at high risk of tumbling further.

The “Buffett indicator” takes the combined market capitalization of all actively traded US stocks, and divides it by the latest quarterly estimate for gross domestic product (GDP). Investors use the yardstick to compare the stock market’s valuation with the size of the economy.

The Wilshire 5000 Total Market Index has plunged 25% this year, driven by the S&P 500, Nasdaq, and Dow Jones indices all declining by over 20% since January. The market-cap index closed at $36.41 trillion on Monday, within touching distance of its June low of $36.36 trillion.

Meanwhile, the Bureau of Economic Analysis’ latest estimate of second-quarter GDP is $24.88 trillion. That puts the Buffett indicator at 146%, down from over 210% at the start of this year.

Buffett implied in a Fortune article in 2001 that stocks would be fairly valued with the gauge at 100%, suggesting they remain substantially overpriced today. Buying stocks would be “likely to work very well” at a 70% or 80% level, but would be “playing with fire” around the 200% mark, he wrote.

In the article, the billionaire investor trumpeted his namesake indicator as “probably the best single measure of where valuations stand at any given moment.” He noted that when it skyrocketed during the dot-com bubble, it should have been a “very strong warning signal” of an impending crash.

Given the precipitous decline in stocks this year, the Berkshire Hathaway’s CEO’s go-to gauge appears to have shown its worth once again.

Still, it’s worth noting that Buffett’s preferred gauge has its flaws. For example, it compares the stock market’s current value with a GDP reading from several months ago. GDP also excludes overseas income, whereas US companies’ market caps reflect the value of both their domestic and foreign operations.

Here’s the St. Louis Fed’s version of the Buffett indicator (both market cap and GDP are indexed to the fourth quarter of 2007):

warren buffett's favorite market gauge is reading nearly 150%, signaling us stocks are still overvalued and at risk of tumbling further

A chart showing the Buffett indicator. St. Louis Fed

Read the original article on Business Insider

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