Warren Buffett's favorite indicator says stocks are overpriced: Here's what actually may be going on (2024)

So far this year, the U.S. stock market, as measured by the S&P 500, has returned about 10% — an average year's worth of gains in just over three months.

After any first-quarter run-up, two brands of market-watchers tend to appear in headlines: those who think stocks can continue to ascend and those who warn that a bubble may be about to pop.

The latest rumbling from the latter camp have pointed out that stocks look overvalued by the standards of none other than Warren Buffett. The so-called Buffett indicator compares the total market capitalization (share prices times outstanding shares) of all U.S. stocks with the quarterly output of the U.S. economy.

Things are in normal territory if the total value of the Wilshire 5000 index (which measures the total market) is about on par with the latest quarterly GDP estimate. If stocks are at about 70% of GDP, they're said to be undervalued. Stocks trading at about double the size of the economy is considered a major red flag.

As of late, the ratio is at about 190% — the highest mark in two years. In calendar year 2022, the last time stocks traded in this territory, the S&P 500 dropped 18%.

So is it time to brace for impact? Not quite yet, says Liz Young, head of investment strategy at SoFi.

"If we're comparing a bubble to the late 90s and early 2000s, no, this is not a bubble," she says. "We're in extended valuations, but we're not outrageous, we're not off the charts."

A 'comforting' situation for stocks

Stick around in markets long enough, and you'll eventually see a bubble pop. This occurs when investors bid up the price of an asset to the point where valuations become untethered from historical norms and underlying fundamentals. When everyone realizes that they've gotten out over their skis, they begin to take profits, prices fall, panic sets in and the asset falls rapidly in value.

Buffett's favorite indicator is a blinking light to investors that stocks are in shaky territory compared with historical norms. But dig into what's been driving stocks, and you'll find that the current run isn't just a product of investor enthusiasm.

"The equity market rally that we've seen so far has been driven by earnings growth," says Gargi Chaudhuri, chief investment and portfolio strategist, Americas, at BlackRock. "If this earnings growth wasn't taking place, I may have been more open to acknowledging the bubble concept."

In short, stocks are doing well because their underlying companies — particularly large, high-quality tech companies – are boosting their profits.

"The most profitable names are doing very well. They're not speculative," Chaudhuri says. "The fact that earnings growth continues to be what's fueling returns is pretty comforting to me and should be to investors as well."

Expect some bumpiness

In many regards, the picture for the economy is rosy, too.

"GDP growth remains strong, the consumer continues to spend and earnings growth as been healthy and above expectations," says Young. "The labor market has stayed strong and inflation has maybe plateaued, but not entirely gone back up again yet. I think that's the fundamental bull case."

Nevertheless, she sees some cracks in the economic façade. While the factors above would indicate that the economy is in the middle of a bull cycle, Young says other indicators are making it look like it's closer to the end.

The longest-ever inversion of the yield curve and a marked uptick in gold prices would both seem to indicate that some pockets of investors are losing confidence in the economy, for instance.

The Fed is performing a tricky tight-rope walk as it plans to slash interest rates this year without retriggering inflation worries, Young says.

"Go back to any recession or economic retraction, and you'll find headlines about the Fed pulling off a soft landing," she says.

Chaudhuri's stock market outlook for the remainder of the year skews more bullish, but she says investors shouldn't expect up-and-to-the-right performance over the next nine months.

"We've seen several weeks of incredible performance. Can we have moments and periods in the equity markets where we get a pullback? Absolutely," she says. "By no means am I trying to say it's up and up and up from here."

Nevertheless, Chaudhuri says diversified stock portfolios will continue to benefit from a growth in corporate earnings and U.S. economic output. With interest rates expected to remain relatively high, investors would be wise to focus on highly profitable companies with little debt, she adds.

"The names that are doing well are the names that are the very highest quality, most profitable companies."

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Warren Buffett's favorite indicator says stocks are overpriced: Here's what actually may be going on (1)

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Warren Buffett's favorite indicator says stocks are overpriced: Here's what actually may be going on (2024)

FAQs

What is the Buffett Indicator overvalued? ›

The Buffett Indicator Model: Overvalued

Summary: The Buffett Indicator is the ratio of the total value of the US stock market versus the most current measure of total GDP. When this value is very high it suggests the stock market is overpriced relative to actual economic productivity.

What is the Buffett Indicator warning? ›

If the stock market is growing a lot faster than the economy, that could be a sign of a bubble. Buffett's Berkshire Hathaway says that a reading of 100% is fair, if it's closer to 70% stocks are at a bargain price, and if it's anywhere near the 200% mark, investors are “playing with fire.”

What indicators does Warren Buffett use? ›

The so-called Buffett indicator compares the total market capitalization (share prices times outstanding shares) of all U.S. stocks with the quarterly output of the U.S. economy.

What is Warren Buffet saying about the stock market? ›

Warren Buffett Says the Stock Market Is Like a Casino — Investors Should Resist 'Foolishness' Pete Grieve is a personal finance reporter. In his time at Money, Pete has covered everything from car buying to credit cards to the housing market.

What is the most overvalued stock right now? ›

Most overvalued US stocks
SymbolRSI (14)Price
MCAC D88.6911.24 USD
INAQ D88.0911.23 USD
DCPH D86.0325.33 USD
LABP D85.9522.27 USD
29 more rows

How accurate is the Buffett Indicator? ›

The Buffett Indicator forecasted an average of 83% of returns across all nations and periods, though the predictive value ranged from a low of 42% to as high as 93% depending on the specific nation.

What is Warren Buffett's top investing rule? ›

Rule 1: Never lose money.

By following this rule, he has been able to minimize his losses and maximize his returns over time. He emphasizes this so much that he often says, “Rule number 2 is never forget rule number 1.”

What is the average Buffett Indicator? ›

In a Forbes interview in December 2001, Warren Buffett said that the ratio is a useful tool for gauging the overall valuation of the stock market, where a range of 75-90% is reasonable; over 120% suggests the stock market is overvalued. The ratio of market capitalization to GDP is also known as the Buffet Indicator.

Is the stock market overvalued right now? ›

Based on the latest S&P 500 monthly data, the market is overvalued somewhere in the range of 92% to 154%, depending on the indicator, up from last month's 88% to 148%. This is the highest range we have seen since January 2022.

How many hours a day does Warren Buffett read? ›

Indeed, the Oracle of Omaha has said that he spends “five or six hours a day” reading books and newspapers. And while it may be difficult to set aside nearly a full work day's worth of hours to read, it recently got a little bit easier to consume information like Warren Buffett.

Which stocks are currently undervalued? ›

Undervalued stocks
S.No.NameROCE %
1.Reliance Home257.70
2.Cons. Finvest65.96
3.Andhra Paper51.95
4.Shreyans Inds.30.99
7 more rows

What type of trading does Warren Buffett use? ›

Buy And Hold For The Long Term

Buffett is known as a buy-and-hold investor, hanging on to stocks for years and even decades.

What are Warren Buffett's 5 rules of investing? ›

Here's Buffett's take on the five basic rules of investing.
  • Never lose money. ...
  • Never invest in businesses you cannot understand. ...
  • Our favorite holding period is forever. ...
  • Never invest with borrowed money. ...
  • Be fearful when others are greedy.
Jan 11, 2023

What is Warren Buffett buying now? ›

Stocks Warren Buffett recently bought or added

Berkshire has also disclosed some additional buying in the first quarter of 2024. The conglomerate bought more shares of two tracking stocks -- Liberty SiriusXM Series A (LSXMA -6.05%) and Liberty SiriusXM Series C (LSXMK -5.83%) -- and boosted its position in Occidental.

What stocks made Warren Buffet the most money? ›

Top 10 holdings in the Warren Buffett portfolio
  • Apple (AAPL).
  • Bank of America (BAC).
  • American Express Co. (AXP).
  • Coca-Cola Co. (KO).
  • Chevron (CVX).
  • Occidental Petroleum (OXY).
  • Kraft Heinz (KHC).
  • Moody's Corp. (MCO).
Mar 19, 2024

What is the fair value of the Buffett Indicator? ›

Also, the market may be fair valued if the ratio falls between 75% and 90%, and modestly overvalued if it falls within the range of 90 and 115%. The stock market capitalization-to-GDP ratio is also known as the Buffett Indicator—after investor Warren Buffett, who popularized its use.

How do I know if a stock is overvalued? ›

This ratio is used to assess the current market price against the company's book value (total assets minus liabilities, divided by number of shares issued). To calculate it, divide the market price per share by the book value per share. A stock could be overvalued if the P/B ratio is higher than 1.

What is considered overvalued? ›

What Is "Overvalued"? An overvalued stock has a current price that is not justified by its earnings outlook, known as profit projections, or its price-earnings (P/E) ratio. Consequently, analysts and other economic experts expect the price to drop eventually.

How do you know if a market is overvalued? ›

Under normal circumstances, the market capitalization is almost equal to the GDP. If this ratio falls below 0.7 or so, it could mean that the market is undervalued and could provide a buying opportunity. On the other hand, if this ratio crosses above 1.25, the market is said to be overvalued.

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