Buffetts Favorite Indicator Sends A Warning To All Investors

Speaker 1: Warren Buffett, OK, yep, we all recognize he’s the greatest investor of all time, he’s the one guy that I know I can go to for reliable information on the stock market. I’ve been paying close attention to him for years upon years now. And I got to say, there’s something that’s come up recently that has got me very concerned on the stock market’s future.

OK, let me break this down. Warren Buffett, he’s not known as a guy for timing the market, but the one indicator that he does look at to see where stocks stand is the market cap to total GDP. It’s now been named the Buffett Indicator because he’s the one who’s made us so famous. He said back in the day that this indicator is probably the best single measure of where valuations stand at any given moment. So I just want to explain a bit about this indicator before we take a look at what it tells us. So the first part of the equation is the market cap, basically saying how much a stock selling for thus gives us a good look at the stock market as a whole. The next part of the equation is total GDP. By the way, GDP stands for gross domestic product. Put simply, how much is the world producing? How well is the economy going? So the first part of the equation is measuring the stock market. The other part, the economy. Now, the interesting thing is if we take a look at the global indicator, we can see that it’s just surpassed that 100 no threshold. That means that stocks are now overvalued compared to what they are actually producing. But please remember that this is the global indicator. So it’s measuring the world’s entire economy and the entire stock market as a whole is not nailed down to one country.

So let me show you what this means. A number over 100 means that the stock market is priced higher than what the economy is actually producing. You see water stocks, stocks are businesses that produce, a.k.a., they make up the economy. So you’d want the market cap or the prices of stocks to be cheaper compared to the GDP to what they actually producing. While at the moment that is not the case anymore when it comes to the world situation as a whole. Essentially, it’s showing us the striking gap between the record high prices of stocks and the depressed economy that we’ve seen recently. So that’s the global buffa indicator. The world indicator. What I want to do now is something arguably more important. And look at the Buffett indicator when it comes to the USA. And by the way, guys, I’m sorry, but it’s not good news. The situation in the USA is actually worse than the world. One currently the Buffa indicator is sitting at 131 percent. That means it’s currently modestly overvalued with anything above 134 per cent that’s considered to be significantly overvalued. So it’s almost getting to that stage. And you got to remember what Buffett said about the indicator and a stock crash back in the day. He said back in 2001 that when the indicator hit a record high in the months before the dotcom crash, it should have been a very strong warning signal. So where around that stage now with this indicator becomes a warning signal to all investors that, yeah, OK, you can invest, but you’re investing at high valuations compared to what the stocks are producing. Because, you know, look at the stock market. It’s just had its best 100 day run since 1933. This has now led on to stocks being priced at pretty much record highs. Looking at the S&P 500, it’s now recovered to what it was even before the world illness hits, which, let’s be honest, that’s pretty crazy, because before the world illness hit, it was justified that stock prices were so high. The economy had had its longest economic expansion of 128 months from 2009 to 2020. Unemployment was low at around three to four percent and real GDP was high at 19 trillion dollars in 2019. But then the illness hits and the economy takes a tumble. Real GDP fell by nearly 38 percent in the second quarter of 2020 and minus eleven point two percent in the first quarter. Mortgage applications fell 30 percent in April 2020 vs. April 2019, and consumer spending fell 17 percent from February to April.

Unemployment, well, that was pretty bad. It went from three point seven percent before the illness to ten point four percent after. As you can see, the USA was hit far greater than most countries, so. Surely all of this should mean the stock market falls as well. Yes, it did initially fall, but now it’s recovered to its previous levels, meaning there’s now a stark difference between the prices of stocks and the underlying economy. You know, if we look at some of the major stocks that make up the U.S. market, what’s going on is pretty crazy. Apple stock just over the past couple of months has doubled in price. It’s up 100 percent, 230 dollars in March to four hundred sixty dollars in August. But the question you have to ask is, why are they selling more phones, more computers, more iPads, etc., or an even better question in the future? Will they sell more after the shutdown that we’ve experienced? You’d have to say no, because people will have less spendable income for these types of items. So do they justify this massive gain? That’s the question you need to ask yourself. Facebook stock, that’s another example. That’s up 75 percent in just four months. One hundred and fifty dollars to two hundred sixty dollars. And if you think about the long term prospects of Facebook, well, in some way, yes, things are good because more and more people are on their phones and let’s be honest, addicted to social media. But how do they get their revenue? Advertisers and advertisers going forward have less of a budget to spend, meaning less potential revenue growth for Facebook, Amazon. It’s another example of one of those stocks where the price just doesn’t seem to justify the underlying fundamentals of the stock. Now, this company is up 75 percent in price since March. Yes, more and more people are buying things online, but also people in general have less money to spend as well. So does Amazon justify a 75 percent increase? It’s a fair argument to say no. These are just a few examples of stocks with a price absolutely being driven up. But the fundamentals of the business don’t necessarily look any better. In fact, they look worse. And technology stocks are the ones that have gone up by the most. But all stocks, generally speaking, have been on fire the past couple of months. This graph goes over all of the stocks in the S&P 500. And as you can see, it’s just green all around. It doesn’t matter if you’re talking about the technology sector, the financial sector, communications, industrials, pretty much all of these. And the light green shade, meaning they’re up by 18 percent or more.

Then if we take a look at the world side of things, the global side of things, it’s a similar story. These stocks over the past couple of months have just been rising and rising from the likes of Canada, China, France, Germany. All of these investors have been loving these recent gains. If you looked at this map and then I told you what had happened with regards to the economy and the world situation, you probably wouldn’t believe me. So I guess the next logical question leads onto why why is this happening where you’ve got the Buffa indicator signaling overvalued stocks, the economy looking bleak, yet prices at all time highs. Are investors just being silly or greedy? Well, there are a couple of things that we must mention. First of all, why are prices high while the government’s been injecting a lot of money into the system, as soon as the whole situation was hit, one point five trillion dollars was pumped into the banking sector over two days in the form of short term loans. Also, the corporate debt market was propped up with a 750 billion dollar program from the Fed. So all of this money is injected into these businesses, into these stocks, and helps propel the prices higher. But you got to remember that these are loans. So one day they’ll have to be paid back along with interest. That’s another thing we need to talk about interest rates. We all know that right now they’re close to all time lows, zero point twenty five percent. That’s pretty much nothing. So what are you going to do, put your money in the bank? Most people aren’t going to do this because they get close to no interest. And in fact, you’re actually losing money because inflation eats away at your savings. So what most people are doing with spare cash is that either going into real estate, precious metals or the stock market. What this does to the stock market is it raises prices, which is exactly what we’re seen in these current market conditions. So Warren Buffett, yes, he has refrained a lot over this past year from buying stocks. In fact, the main thing that he has been doing is selling stocks.

As we all know, he got rid of those airlines not long ago. He let go of a decent amount of his bank shares and he’s trimmed a couple of other positions. So when you look at the Buffett indicator. When you look at his stock moves in the market, it does send a bit of a warning to all investors out there to be careful with the stocks they buy and the way they organize their portfolio.

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