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What The Buffett Indicator Means For Stocks

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What The Buffett Indicator Means For Stocks

Back in 2001, the most iconic investor of all time, Warren Buffett, said that market cap to GDP ratio is “probably the best single measure of where valuations stand at any given moment.” Since then, Wall Street has referred to the metric as the “Buffett Indicator.”

Simple Idea

The Buffett Indicator is an extremely simple concept: it is a measure of the size of the stock market compared to the size of the actual U.S. economy. To Buffett, this number is a clear indication of how expensive share prices are in real time.

The Numbers

The latest Buffett Indicator ratio comes in at 127.1 percent. The ratio’s long-term historical mean is right around 70 percent with a standard deviation of just less than 25 percent.

From a historical perspective, the Buffett Indicator is sky-high at the moment, sitting more than two standard deviations above its mean. It’s currently at its highest point since the Dot-Com Bubble back in 2000, and is much higher than it was during the peak of the Housing Bubble back in 2007.

In His Own Words

So does Warren Buffett think it’s time to start dumping stocks? He was asked about the ratio at a Berkshire Hathaway Inc. (NYSE: BRK-A)(NYSE: BRK-B) shareholder meeting earlier this year, and he was not particularly concerned. According to Buffett, historically low interest rates are to blame for the elevated ratio.

“If we continue with these interest rates, stocks will look very cheap,” Buffett explained.

However, he added that a transition to normalized interest rates would leave stock valuations on the high side of their historical range. The interest rate normalization process could begin as soon as this month, with the Federal Reserve announcing its decision on September 17.

 

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