A favorite Warren Buffett stock market metric is at an all-time high, which could signal a crash is in our near future. Dubbed the “Buffett Indicator,” the billionaire’s metric is signaling that the stock market is a bit overheated and that the bubble will soon burst.
According to CBS News, the Buffett Indicator, while it’s not a flawless indicator, does tend to peak during hot stock markets and bottom during weak markets. As a general rule, if the indicator falls below 80%-90% or so, it has historically signaled that stocks are cheap. On the other hand, levels significantly higher than 100% can indicate stocks are expensive. For example, the Buffett indicator peaked at about 145% right before the dot-com bubble burst and reached nearly 110% before the financial crisis.
The Buffett Indicator is a simple metric to calculate, too. Just divide the total market capitalization of all U.S. stocks by the latest gross domestic product or GDP. Basically, the Buffett Indicator can simply tell you the valuation of the stock market in a historical context right now. It doesn’t predict tops or bottoms.
But, according to further reporting by CBS News, at nearly 149%, the total market cap to GDP ratio has never been higher. It’s even higher than the 145% peak we saw during the dot-com bubble. There are some good reasons for high valuations, such as the new, lower corporate tax rate, the generally business-friendly administration, a prolonged period of historically low interest rates, low unemployment, high consumer confidence, and soaring corporate earnings, just to name a few.
But the writings are on the wall. Many financial analysts have said that this is the biggest bubble in history and when it pops, it could devastate the global economy, lowering the living standards for almost everyone.
While the Buffett Indicator is certainly a great snapshot of stock valuations, it’s also not a stand-alone metric that anyone should use to determine when to buy or sell. When asked about the Buffett Indicator and another favorite metric at Berkshire’s 2017 annual meeting, Buffett said, “It’s just not quite as simple as having one or two formulas and then saying the market is undervalued or overvalued.”