Warren Buffett Indicator refers to the total market value of all listed companies in a country, compared to the country’s Gross Domestic Product (GDP). This indicator can be used to assess whether the overall stock market valuation of a country is reasonable. Currently, the Buffett Indicator has reached a historic high, surpassing Buffett’s mentioned “playing with fire” level, once again sparking concerns among investors about reaching the market prosperity limit.
According to an article written by Warren Buffett in Forbes magazine in December 2001, the ratio of total market value of stocks to GDP can be used to judge whether the overall stock market is overvalued or undervalued, hence widely known as the Buffett Indicator. It is used to measure the ratio of total market value of US listed stocks (Wilshire 5000 index) to the US Gross Domestic Product (GDP). A Buffett Indicator ratio between 75% and 90% is considered reasonable, while exceeding 120% indicates an overvalued market.
Famous investors such as Paul Tudor Jones have also referenced this indicator.
Buffett said in a speech in 2001, “If the percentage takes a dive to around 70% or 80%, then buying stocks might be very profitable.” At that time, during the dot-com bubble period, the indicator was close to 150%.
He added, “If the ratio approaches 200% – like it did during certain times in 1999 and 2000 – then you are playing with fire.” Currently, the ratio stands at 217%, far higher than during the dot-com bubble peak and the level it surpassed during the stock market rebound in 2021 amid the pandemic.
CNBC financial website reported on September 28th that by this standard, the current stock market is in uncharted territory, as the expansion rate of stock values far outpaces the overall economic growth of the US. The market rebound is driven by large tech companies investing billions in artificial intelligence development, as the prospects of this new era bring them lucrative price-to-earnings ratios.
Other valuation indicators are also sending similar signals. According to Bespoke Investment Group, the price-to-sales ratio of the S&P 500 index recently reached 3.33, hitting a historical high. In contrast, during the dot-com bubble period in 2000, the price-to-sales ratio peaked at 2.27, and during the prosperity period after the pandemic, it reached 3.21 before valuation cooled down.
The financial and investment advice website The Motley Fool wrote that the US stock market is showing signs of an unstoppable bull market or a potential collapse. The challenge lies in determining which scenario is more likely to occur.
The article mentions that if there is a stock that can capture this situation, it is undoubtedly Tesla. Over the past 12 months, the stock has undergone a tumultuous journey, plummeting to a 52-week low of $212, then surging to a high of $488.
The difference between these two extremes is 2.3 times. Such volatility is common in the UK penny stocks. But this company has a market capitalization of $1.4 trillion, nearly six times that of HSBC Holdings, a component of the FTSE 100 index.
Tesla currently has a forecasted price-to-earnings ratio of 295 times. Whether this is reasonable depends on people’s actual perception of the company.
If Tesla is just an electric car manufacturer, then such a high valuation may seem a bit crazy. But if it truly represents the future of autonomous driving, robotics, and artificial intelligence, who knows?
On the other hand, some argue that the Buffett Indicator may no longer convey the same message as before. Over the past two decades, the US economy has undergone significant changes, with reduced asset intensity, increasingly driven by technology, software, and intellectual property. GDP and GNP may underestimate the value of an economy built on data networks and innovation rather than physical factories. Therefore, the US remains the strongest economy in terms of productivity and innovation, and higher stock valuations may be justifiable.
Warren Buffett has not commented on this indicator for many years. However, over the past two years, he has been building a cash fortress at Berkshire Hathaway. The second-quarter financial report shows that the group’s cash reserves reached $344.1 billion, and for the 11th consecutive quarter, stocks were net sold. While there is a possibility that this indicator may be outdated, considering Buffett’s current holdings, such extreme indicator data undoubtedly raises concerns among some.
Regardless of whether the indicator is outdated, these numbers cannot be ignored. The market price-to-economic ratio stands at 217%, higher than at any point in history.
(This article is for general information purposes only, with no intention to recommend. The Epoch Times does not provide investment, tax, legal, financial planning, real estate planning, or other personal financial advice. For specific investment matters, consult your financial advisor. The Epoch Times does not assume any investment responsibility.)