Warning! "Buffett Indicator" Issues a Warning: U.S. Stocks Are Just Too Expensive
Buffett Indicator warns investors that US stocks are overvalued. According to the Buffett Indicator, the total market value of US stocks as a percentage of GDP has risen to levels not seen since 2022. Historically, such a rise has foreshadowed a significant decline in the S&P 500 Index. In addition, other popular valuation indicators also indicate that stock valuations are too high. However, the Buffett Indicator has some flaws, such as not taking into account factors like interest rates and the increasing share of profits from foreign companies. Investors should closely monitor changes in these indicators
The Buffett Indicator is sending a warning to investors.
A hedge fund founder believes that the message from this indicator is very clear, indicating that the U.S. stock market appears to be very expensive. The Buffett Indicator is calculated by dividing the total market capitalization of all actively traded U.S. stocks by the latest estimate of the Gross Domestic Product (GDP) for the quarter. As early as 2001, Buffett stated that this "may be the best single measure of where valuations stand at any given moment."
In early July, this ratio rose above 2, reaching a level not seen since the beginning of 2022. According to FactSet data, the last time this ratio rose, it foreshadowed the worst annual decline in the S&P 500 Index since 2008.
Hedge fund Seabreeze Partners Management founder Doug Kass said, "Nearly two years ago, this ratio rose to unprecedented levels. This should be a very strong warning signal."
It is worth noting that Buffett himself no longer relies on this indicator, but investors like Kass still use it to help determine whether stocks are cheap or expensive.
The indicator has been quite reliable and reasonable in the past. It has previously shown extreme overvaluation of stocks relative to U.S. economic output, predicting major sell-offs in 1987 and 2000, as well as on the eve of the financial crisis.
Overall, Kass stated that when this indicator reaches two standard deviations above its long-term average, investors should take notice. Today, it is at that level.
Currently, the Buffett Indicator is not the only signal indicating overvalued stocks. Kass mentioned that other popular valuation indicators, including the price-to-earnings ratio, price-to-sales ratio, and enterprise value-to-sales ratio over the past 12 months, are all in the 90th percentile relative to history.
Like other indicators, the Buffett Indicator also has its flaws. One issue is that it does not consider interest rates, which are currently at their highest levels in over 20 years. Kass also pointed out that it does not account for the fact that foreign corporate profit shares have been increasing. "Portfolios are very complex, and no single indicator is foolproof."
Another potential issue unique to today is that most of the market's gains over the past 18 months have been driven by a few large-cap stocks. This means that the indicator may overlook the view that many stocks are still relatively cheap compared to history, while a few stocks are extremely expensive.
According to FactSet data, the S&P 500 Index reached its 36th record closing high of the year on Tuesday. The NASDAQ Composite Index also hit a new high, while the Dow Jones Industrial Average once again lagged behind, in a downward trend