Buffett’s indicator predicts collapse

The message is clear, according to the hedge fund. Seabreeze Partners Management: US stocks look great value. Be careful.

This says Market monitoring Based on the Buffett Index. It compares the value of the U.S. stock market to the size of the economy by dividing total market capitalization by GDP. Major investor Warren Buffett has called it “perhaps the best measure of valuations.”

very expensive stocks

In early July, the ratio rose above 2, reaching a level not seen since early 2022. That previous episode marked the worst calendar-year decline for the S&P 500 since 2008, according to data from FactSet.

“Almost two years ago, the ratio rose to unprecedented levels. That should have been a very strong warning sign,” said Doug Kass, founder and president of hedge fund Seabreeze Partners Management.

In the years since the index was first put on the radar—and it was immediately named—the man known as the Oracle of Omaha has downplayed its importance, but investors like Kass still use the Buffett Index to determine where stocks are on the spectrum from very cheap to very expensive.

Previous results

In the past, the Buffett Indicator has proven to be very reliable. Previous times when the indicator indicated that stocks were too overvalued relative to U.S. economic output were before the crashes of 1987 and 2000, and again in the run-up to the financial crisis.

In general, investors should be vigilant if the index moves two standard deviations above its long-term average, Kass said. Like now.

There is no perfect indicator.

Right now, the Buffett Indicator isn’t the only indicator showing that stocks appear overvalued. Other common valuation metrics — including trailing-12-month price-to-earnings ratio, price-to-sales ratio and stock market value-to-sales ratio — are also too high. About 90 percent of the time, Kass said, they’re undervalued.

Like other valuation measures, the Buffett Index has its drawbacks. One is that it doesn’t include interest rates, which are currently at their highest level in more than 20 years. It also doesn’t take into account the growing share of corporate profits coming from abroad, or phenomena like the Seven Wonders. A handful of stocks have been responsible for most of the price gains over the past year and a half. That means the index can obscure the fact that many stocks remain historically cheap, while a small minority are very expensive.

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