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- Warren Buffett’s favorite stock gauge has hit a record high, signaling that stocks are overvalued and that a crash could occur.
- The “Buffett indicator” divides the total value of publicly traded stocks by quarterly GDP.
- “This is probably the best single measure of the valuation situation at any given time,” Buffett wrote in a 2001 Fortune article.
- Famed investor and boss of Berkshire Hathaway said it was “a very strong warning signal” when the indicator peaked just before the bubble burst.
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Warren Buffett’s favorite stock indicator has hit a record high, signaling that stocks are overvalued and that another crash could occur.
The indicator says Buffett takes the combined market capitalizations of the publicly traded stocks of a country and divides them by the quarterly gross domestic product. Investors use it to assess whether the stock market is overvalued or undervalued relative to the size of the economy.
Buffett, a billionaire investor and the owner of Berkshire Hathaway, described it in a Fortune magazine article in December 2001 as “probably the best single measure of the valuation situation at any given time.”
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The indicator has its shortcomings, notably GDP, not counting revenues earned abroad and companies listed in the United States which do not necessarily contribute to the American economy.
But it has a solid track record in forecasting downturns – for example, it jumped 118% just before the Internet bubble burst in 2000, and reached 100% before the 2008 financial crisis.
“Almost two years ago, the ratio hit an all-time high,” said Buffett in the Fortune article. “It should have been a very strong warning signal. “
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The Buffett indicator reached a historic high of 179% on Thursday, reflecting the rapid rebound in the US stock market since the sale of coronaviruses and the 4.8% drop in annualized GDP last quarter. Its current level has been well above the average reading of 107% over the past 20 years.
Several market commentators have questioned whether US stocks are overvalued in light of slowing economic growth, rising unemployment and other alarming data in recent weeks. The last reading of the Buffett indicator should add more weight to their concerns.
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