Article by Theron Mohamed in Business Insider
Warren Buffett’s favorite market gauge is flirting with a fresh high, signaling stocks are overvalued and could plunge in the coming months.
The “Buffett indicator” divides the total market capitalization of a country’s publicly traded stocks by its quarterly gross domestic product. Investors use it as a rough measure of the stock market’s valuation compared to the size of the economy.
The Wilshire 5000 Total Market Index surged in value to an unprecedented $38.2 trillion on Tuesday, while the latest official estimate for third-quarter GDP is $21.2 trillion.
Dividing those numbers shows the Buffett indicator has cleared 180%. Buffett described his namesake gauge in a Fortune magazine article in 2001 as “probably the best single measure of where valuations stand at any given moment.”
The famed investor and Berkshire Hathaway CEO added that when the ratio spiked to a record high during the dot-com boom, it “should have been a very strong warning signal” of an impending crash. The Buffett indicator also surged in the months before the 2008 financial crisis, giving it a solid track record of predicting market downturns.
The COVID-19 pandemic has also caused massive disruptions to economic activity and temporarily depressed GDP, boosting the Buffett indicator’s readings in recent months. However, stocks appear extremely expensive by several other measures, suggesting the gauge ….
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