- The Buffett indicator flashed red right before the Great Recession hit in 2008 and the Dot Com bubble crashed in 2000.
- Today it indicates the stock market is in an even worse bubble than the last two times valuations collapsed.
- Before the Dot Com crash, Warren Buffett predicted stock returns would fall dramatically in a rare 1999 speech about the overall market.
The U.S. stock market kicked off the new decade at record highs. There are plenty of good reasons for the bulls’ optimism. The cooling trade war, sliding recession risk, rising employment, and blue chip tech leadership are positive macro tailwinds.
But for those wondering how much longer the record-long bull market can last, the so-called Buffett indicator has a dreadful answer.
Buffett Indicator Flashes Red for Stocks
Named after the widely-venerated “Oracle of Omaha,” the Buffett indicator reflects Warren Buffett’s characteristically simple thinking about stock values. It’s the total stock market capitalization of the United States relative to U.S. GDP.
If the indicator gets too top heavy, with the total market value of stocks significantly exceeding the productivity of the underlying companies, Buffett would say stock prices are due for a correction. The historical returns of the stock market back him up on that.
Today the indicator is soaring at a harrowing record high.
Just before the Dot Com Bubble collapsed, total U.S. market cap stood at 146% of GDP, according to the Federal Reserve’s books. Right before the Great Recession that began at the end of 2007, the U.S. market cap was 137% of GDP.
On the first day of trading in 2020, the Buffett indicator charted an ominous high of 153%, according to Wilshire data. As the stock market set records in the final quarter last year, the indicator rose 14% in one quarter. And corporate earnings growth is flat.
That’s why this Nov 2019 headline from CNBC is silly:
Warren Buffett has $128 billion in cash to burn and analysts can’t figure out why he isn’t spending it.
Buffett already explained why two decades and two recessions ago.
‘Mr. Buffett On The Stock Market’
Fortune ran an article in 1999 reporting Warren Buffett’s rare remarks on the overall stock market. In the speech, given ahead of the Dot Com crash that would take the Nasdaq Composite years to recover from, Buffett predicted a market correction ahead.
He argued that traders can profit from a bubble in the short term by selling equities to each other. But in the final reckoning, stock values will average out to the ability of the underlying businesses to deliver profits.
Or as Buffett once told shareholders at an annual Berkshire Hathaway meeting, investors aren’t investing in “lines that wiggle up and down on a graph.”
His 1999 remarks spell doom after the stock market’s bull run in 2019:
The fact is that markets behave in ways, sometimes for a very long stretch, that are not linked to value. Sooner or later, though, value counts.
He summarized the nature of equities bubbles:
Bear in mind–this is a critical fact often ignored–that investors as a whole cannot get anything out of their businesses except what the businesses earn. Sure, you and I can sell each other stocks at higher and higher prices.
And described the hard limit on stock returns:
The absolute most that the owners of a business, in aggregate, can get out of it in the end–between now and Judgment Day–is what that business earns over time.
If you go by the Buffett indicator, Wall Street is partying like it’s 1999.
This article was edited by Sam Bourgi.