Warren Buffett's preferred market gauge hit 205%, signaling stocks are heavily overvalued.
The "Buffett indicator" compares the stock market's valuation to the size of the economy.
Buffett has said the gauge spiking is a "very strong warning signal" of a future market crash.
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Warren Buffett's favorite market indicator has climbed to 205%, signaling stocks are vastly overpriced and a crash may be coming.
The "Buffett indicator" takes the combined market capitalization of all publicly traded US stocks, and divides it by the latest quarterly figure for gross domestic product. It serves as a rough gauge of the stock market's valuation relative to the size of the economy.
The Wilshire 5000 Total Market Index closed just shy of $46.69 trillion on Wednesday, as the S&P 500 and Nasdaq indexes ended the day at record highs. Meanwhile, the latest estimate for second-quarter GDP is $22.72 trillion, putting the Buffett indicator at 205%. That reading is well above the 187% it reached in the second quarter of 2020, when the pandemic was in full swing and GDP was about 15% lower.
Buffett praised his namesake gauge in a Fortune magazine article in 2001, touting it as "probably the best single measure of where valuations stand at any given moment."
When the indicator surged to a record high during the dot-com bubble, it should have been a "very strong warning signal" of an impending crash, the famed investor and Berkshire Hathaway CEO added. The yardstick also soared in the lead-up to the global financial crisis, making it a useful tool for anticipating downturns. Both times, the indicator remained under 150%.
However, the gauge is far from perfect. For example, it compares the previous quarter's GDP to the stock market's value today. GDP also excludes overseas income, whereas US companies' market caps reflect the value of both their domestic and international operations.
Moreover, the pandemic has disrupted economic activity and depressed GDP since last spring, while also spurring the federal government to support companies, propping up markets in the process. As a result, the Buffett indicator's readings may be artificially inflated, and could fall as the economy recovers and corporate aid is withdrawn.
Buffett's indicator isn't alone in predicting a painful sell-off. Michael Burry, the investor of "The Big Short" fame, warned earlier this year that the stock market is "dancing on a knife's edge" and the "mother of all crashes" is coming. Jeremy Grantham, the market historian and GMO cofounder, has also sounded the alarm on a "fully-fledged epic bubble" that he expects to burst spectacularly.
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):
St. Louis Fed
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