Buffett Indicator Breaks 200% Caution Line, S&P 500 Index "Extremely Dangerous"

Intelligent Finance APP noticed that Warren Buffett's favorite stock market valuation indicator has just hit a historical high, indicating that the stock market may be overvalued.

Last Monday, the Buffett Indicator, which measures the total market value of the U.S. stock market relative to the U.S. GDP, reached a historical high of 200%, surpassing the previous historical high of 197% set in November 2021.

In other words, measured by the Wilshire 5000 Index, the total market value of the U.S. stock market is about $55 trillion, roughly twice the annualized GDP of the United States (approximately $27 trillion).

Shortly after the Buffett Indicator peaked in November 2021, the stock market experienced a painful bear market lasting for a year.

In 2001, Buffett referred to this indicator as "probably the best single measure of where valuations stand at any given moment."

Buffett stated that when the indicator reached an unprecedented level of about 190% during the dot-com bubble in 2000, "this should be a very strong warning signal."

"For me, the message from this chart is: if the percentage drops to the 70% to 80% range, buying stocks could be very advantageous for you. If this ratio approaches 200%—as it did at times in 1999 and 2000—you are playing with fire."

Fast forward to 2024, investors seem to be playing with fire.

In a report last Thursday, B. Riley strategist Paul Dietrich pointed out that the Buffett Indicator has reached unprecedented levels, which is one reason investors should be cautious about stocks.

Chris Bloomstran, fund manager at Semper Augustus, stated in an interview that although the Buffett Indicator is somewhat flawed, it is worth paying attention to as an investor.

Bloomstran said, "I think it's useful, it's likely a mean-reverting series, which is effective."

However, investors need to apply the "rising trend channel" to the indicator to explain the changes in the current economy compared to the past.

The current U.S. economy is structurally different even from decades ago, with significantly higher corporate profit margins, more asset-light companies in the technology sector, greater globalization, and markedly different interest rates and inflation levels.

Bloomstran explained, "So if profits are higher, profit margins are also higher, naturally the price you pay for profits, the price-earnings multiple, if you keep the price-earnings ratio constant, you're applying it to a higher profit margin, so that will push up your market value relative to GDP."

Bloomstran added, "You can't compare today's market to the market in 2000 or 1929 because these indicators are so different at different times."

However, Bloomstran stated that despite the flaws in the Buffett Indicator, at its current level, it sends a significant warning signal to stock market investors "I think this is screaming, the market-cap weighted stock market, namely the Wilshire 5000 Index and the S&P 500 Index, is very dangerous today. I think if you hold the S&P 500 Index in a market-cap weighted situation, you are in trouble," Bloomstran said. "This is definitely a long-term peak."