With U.S. equity indexes rising to fresh records again this week, one of Warren Buffett’s most-famous catchphrases comes to mind: Investors should “be fearful when others are greedy.”
Any Buffett disciple who checks in on the billionaire investor’s favorite market valuation metric these days may get the urge to shriek in terror.
The “Buffett Indicator” is a simple ratio: The total market capitalization of U.S. stocks divided by the total dollar value of the nation’s gross domestic product. It first crossed above its previous dot-com era peak in 2019.
Still, it has been trending higher for decades, and if there’s one mantra investors love even more than Buffett’s it’s, “the trend is your friend.”
A “Strongly Overvalued” Situation
However, in recent weeks, even that long-term trend fails to justify the metric’s frothy appearance. With U.S. market cap more than double the level of estimated GDP for the current quarter, the ratio has surged to the highest-ever reading above its long-term trend, according to an analysis by the blog Current Market Valuation, suggesting a “strongly overvalued” situation.
Of course, with the Federal Reserve holding rates near zero and buying bonds for the foreseeable future, and an abundance of savings and fiscal stimulus set to trigger blockbuster growth in GDP and corporate earnings, it’s fair to wonder if this is yet another of the many false alarms that have sounded during the past decade.
“It highlights the remarkable mania we are witnessing in the U.S. equity market,” said Michael O’Rourke, chief market strategist at JonesTrading. “Even if one expected those (Fed) policies to be permanent, which they should not be, it still would not justify paying two times the 25-year average for stocks.”