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The Buffett Indicator Is Flashing Red
Warren Buffett—the “Oracle of Omaha”
Legendary investor Warren Buffett, the chairman and CEO of Berkshire Hathaway, is considered one of the most successful investors in the world. When he shares his opinions on the economy and the financial markets, investors across the globe are listening, and many are following his predictions. Afterall, the “Oracle of Omaha” has built a fortune of $80 billion through his investments.
The Buffett Indicator is flashing red
Buffett says the “single best” way to tell if stocks are too expensive is to compare two simple numbers: the total value of all equities in the market and the total size of the economy. When the value of all stocks is 80% or less than the size of the economy, “buying stocks is likely to work very well for you,” Buffett wrote in an article for Fortune back in 2001.
But when total equity value exceeds the size of the economy and then some, it’s a sign that investors are getting too giddy—and greedy.
“It is probably the best single measure of where valuations stand at any given moment,” Buffett has said, and the indicator has proven its worth over the past two decades. It was quickly coined the “Buffett Indicator” and has become a valuable tool in the investment industry. The indicator has a solid track record of predicting past downturns—it soared to over 100% before the dot-com crash in 2000 and the 2008 financial crisis.
Today, the Buffett indicator is flashing its biggest warning sign yet. The value of all the equities in the Wilshire 5000 Total Market Full Cap Index (a proxy for the entire domestic market) stands at close to $33.9 trillion. That’s 171.7% of US GDP, up from 124.7% the previous quarter. according to figures tracked on a quarterly basis by the Federal Reserve Bank of St. Louis.
By this measure, stocks are frothier, bubblier, and riskier than they’ve ever been—even in the months leading up to the 2000 crash and the Great Recession.
Buffett is hoarding cash
Recently, Buffett has been mum about his indicator, but he may be letting his portfolio do his talking for him. Those high market valuations may be precisely why Buffett’s investment company, Berkshire Hathaway, is sitting on a record $137 billion in cash on hand. (The company is valued at $475 billion.)
Buffett is on record in previous years saying he actually hates cash because “cash is going to become worth less over time. But good businesses are going to become worth more over time.”
Yet, what Buffett hates more is overpaying for his investments. So the fact that he is willing to hold so much of his company’s assets in cash is a testament to how few bargains he sees in this stock market. And that would confirm what Buffett’s favorite market indicator is now signaling.
Buffett has changed his mind on gold as an investment
Another sign that Buffett is keeping a close eye on his favorite indicator is the fact that he recently dropped a bombshell on the financial community. For the first time ever, he invested in gold.
It’s also worth mentioning that Buffett’s venture into gold investing was the only new investment he made in Q2. He abandoned the US banking sector, selling or significantly reducing his stakes in several major US banks, and joined the ranks of several other billionaire investors who have turned to gold as an investment.
Let’s bring this home
Buffett, the world’s most successful investor for over 40 years, is relying on an indicator for his investments. Right now, the indicator is showing that stocks are overvalued historically—more than they have ever been, including during the days before the famous market crash of 1929.
So, the market is headed to a major correction. Buffett took notice and moved into a huge cash position while investing in gold, waiting for new opportunities when the markets correct and he can buy them on the cheap. He did the same exact thing after 2008.
You and I are not Buffett, but we can take a page from his playbook—reduce risks by reducing paper assets such as equities and bonds and increase upside return and available funds for bargain basement opportunities by moving to cash and gold investing. Your financial advisor may not like this recommendation now, but you sure will later.
CEO, Gold Alliance