Reliable ‘Buffett Indicator’ Flashing Market Crash Warnings

If you’re invested in the stock market, there’s a good chance you are incredibly happy with how the last year has gone — but the so-called “Buffett indicator” is flashing some bad omens for Wall Street’s future.

The signal, named after Berkshire Hathaway’s co-founder and investor extraordinaire Warren Buffett, reflects the “Oracle of Omaha’s” simple approach to investing and stock valuation. It’s just the total stock market capitalization relative to U.S. gross domestic product.

Buffett sees a market correction happening when the indicator gets too top heavy, or when the market value of stocks are vastly outperforming the productivity of the companies that those stocks are based on. Historical data shows some validity to this argument.

The graph above shows how the Buffett indicator has dipped and rose again over the past 20 years up until 2017. Before the dot-com bubble crash of the early 2000s, the Buffett indicator showed U.S. market cap was at 146% of GDP, according to CCN. At the end of 2007, prior to the Great Recession market cap was 137% of GDP.

So what’s the Buffett indicator at now?

On the first trading day of 2020 the market cap hit a record-high 153%, and apparently the indicator rose 14% in the last quarter of 2019 as the stock market seemingly broke into new record highs ever other day.

According to Y Chart data, the market cap in relation to GDP was at 153.1% Tuesday after hitting 153.5% Monday.

That could explain why Buffett and Berkshire Hathaway have been sitting on a $128 billion mountain of cash that he’s been holding onto while searching for an “elephant-sized acquisition” amid prices he considers too high.

His 2019 letter to shareholders predicted exactly that:

“That disappointing reality means that 2019 will likely see us again expanding our holdings of marketable equities,” he wrote. “We continue, nevertheless, to hope for an elephant-sized acquisition.”

Buffett did get into a slight bidding war toward the end of 2019 for a small tech company based out of Florida, but that would have only drained $5 billion from the investor’s record cash hoard if he had won the bid, which he didn’t.

Posted by Eugene Townes | Jan 8, 2020 | Investing, Markets


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