Analysis: Buffett’s favorite market indicator is flashing red | CNN Business (2024)

Analysis: Buffett’s favorite market indicator is flashing red | CNN Business (1)

A key market indicator created by Warren Buffett is flashing warning signs.

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The “Buffett Indicator” is flashing red.

In 2001, Warren Buffett came up with what he called in Fortune Magazine “probably the best single measure of where [stock] valuations stand at any given moment.”

Today that barometer has soared to a two-year high, signaling that a market retreat could be coming.

What’s happening: Widely known as the “Buffett Indicator,” it measures the size of the US stock market against the size of the economy by taking the total value of all publicly traded companies (measured using the Wilshire 5000 index) and dividing that by the last quarterly estimate for gross domestic product.

The resulting ratio is supposed to tell us how fairly priced stocks are by providing a simple gauge of whether the market is overvalued or undervalued relative to economic output. If the stock market is growing a lot faster than the economy, that could be a sign of a bubble.

Buffett’s Berkshire Hathaway says that a reading of 100% is fair, if it’s closer to 70% stocks are at a bargain price, and if it’s anywhere near the 200% mark, investors are “playing with fire.”

The indicator is currently sitting near a two-year high, at nearly 190%.

The last time the indicator was this high was in 2022, when it hit 211% and the S&P 500 dropped by 19% over the next year.

Bubble territory: Markets have surged higher this year as investor enthusiasm over artificial intelligence stocks have sent chipmakers like Nvidia to all-time highs.

Wall Street is also betting that there will be three interest rate cuts by the Federal Reserve this year, and investors have been preemptively celebrating.

But some analysts are ringing the alarm. They’re worried that AI fervor is misguided. Plus, two Fed officials have forecast no interest rate cuts at all this year.

“My impression is that investors are presently enjoying the double-top of the most extreme speculative bubble in US financial history,” legendary investor John Hussman wrote in a recent note. Hussman predicted the 2000 and 2008 market crashes.

Former Treasury Secretary Larry Summers also fretted over markets last week. “I certainly think we’re at least at the foothills of bubbles,” he said on Bloomberg.

Louis Navellier of Navellier & Associates thinks US markets are in a melt-up that’s being widely ignored by investors. “The market continues to march relentlessly higher and no one is willing to call a top,” he said in a note.

The S&P 500 has surged more than 10% since January, and last week it surpassed Goldman Sachs’ year-end target of 5,200. Analysts at the bank now say there’s a scenario where it could rise an additional 15% to 6,000 by the end of the year.

“As always, there are a lot fewer questions about why the market is up than there are when it trades down,” said Navellier.

Yes, but: The so-called Buffett Indicator is not without flaw. It ignores how much money companies make abroad and doesn’t consider how interest rates might change a company’s valuation. Buffett himself has conceded that the very simple metric has its limitations.

And while markets are frothy, they’re not exactly bubbling.

“This is not hype,” JPMorgan Chase CEO Jamie Dimon told CNBC last month about a potential AI bubble. “When we had the internet bubble the first time around… that was hype. This is not hype. It’s real,” he said. “People are deploying [AI] at different speeds, but it will handle a tremendous amount of stuff.”

The froth appears to be settling — about 23% of S&P 500 companies made a new 52-week high last week, and the equal-weighted S&P 500 is up by nearly 25% since its October 2023 low. That makes this market more “believa-bull,” quipped Kevin Gordon, senior investment strategist at Charles Schwab.

But, he told CNN, “we continue to think the market is vulnerable to a looming negative catalyst — particularly on the earnings front — given both attitudinal and behavioral sentiment metrics are in extreme optimism territory.”

The last trading day of the quarter falls on Thursday, and earnings reports begin in early April.

Visa and Mastercard agree to $30 billion settlement that will lower merchant fees

Two of the world’s largest credit card networks, Visa and Mastercard, as well as the banks that issue cards with them, have agreed to settle a decades-long antitrust case brought upon by merchants, reports my colleague Elisabeth Buchwald.

The settlement is set to lower swipe fees merchants pay when customers make purchases using their Visa or Mastercard by $30 billion over five years, according to a press release announcing the settlement Tuesday morning.

The settlement, which only applies to US merchants, is the result of a lawsuit filed in 2005. However, nothing is considered finalized until it receives approval from the US District Court for the Eastern District of New York. Even then, the case can also be appealed in what could be a lengthy battle.

Typically, swipe fees cost merchants 2% of the total transaction a customer makes —but can be as much as 4% for some premium rewards cards, according to the National Retail Federation. The settlement would lower those fees by at least 0.04 percentage point for a minimum of three years.

Trump’s Truth Social is now a public company. Experts warn its multibillion-dollar valuation defies logic

For the first time in almost 30 years, part of Donald Trump’s business empire has gone public. Trading started with a bang, but the frenzy eased considerably by the closing bell, with shares ending well off their highs of the day, reports CNN’s Matt Egan.

Trump Media & Technology Group, the owner of struggling social media platform Truth Social, began itslong-delayed journey as a public companyat Tuesday’s opening bell under the ticker symbol “DJT.”

The stock surged about 56% at the open, to $78, and trading was briefly halted for volatility. Trump Media shares stabilized around $70 before fizzling. By the closing bell, Trump Media ended at $57.99, up by a more modest 16% on the day.

The skyrocketing share price comes despite the fact that Trump Media is burning through cash; piling up losses; and its main product, Truth Social, is losing users.

“This is a very unusual situation. The stock is pretty much divorced from fundamentals,” said Jay Ritter, a finance professor at the University of Florida’s Warrington College of Business, who has been studying initial public offerings (IPOs) for over 40 years.

Ritter said the closest parallel would be GameStop, AMC andother so-called meme stocks that skyrocketed during Covid-19as an army of retail traders piled in. He said Trump Media is likely worth somewhere around $2 a share — nowhere near its closing stock price of $58.

Analysis: Buffett’s favorite market indicator is flashing red | CNN Business (2024)

FAQs

Analysis: Buffett’s favorite market indicator is flashing red | CNN Business? ›

The “Buffett Indicator” is flashing red. In 2001, Warren Buffett came up with what he called in Fortune Magazine “probably the best single measure of where [stock] valuations stand at any given moment.” Today that barometer has soared to a two-year high, signaling that a market retreat could be coming.

How to interpret the Buffett Indicator? ›

Interpreting the Market Cap to GDP Ratio

A Price/Sales ratio of greater than 1.0x (or 100%) is generally considered a sign of being highly valued, while companies trading below 0.5x (or 50%) are considered to be cheap.

What is the Buffett Indicator warning? ›

Think of the Buffett Indicator as a broad way to assess whether a country's stock market is overvalued or undervalued. Brace yourself for a possible wave of selling, because the indicator for the U.S. has reached a disturbingly high level.

Is the Buffett Indicator accurate? ›

If you looked at major market declines in the US since 1971, this indicator gave warning signals ahead of 50% of them. But if you came further and looked at data since 2000, then the Buffett Indicator successfully predicted about 57% of the major market declines.

What is the Buffett Indicator for 2024? ›

As of 2024-06-21 03:15:00 PM CDT (updates daily): The Stock Market is Significantly Overvalued according to Buffett Indicator. Based on the historical ratio of total market cap over GDP (currently at 192.6%), it is likely to return 0.1% a year from this level of valuation, including dividends.

What is the formula for the Buffett Indicator? ›

The Buffett Indicator is the ratio of total US stock market value divided by GDP. Named after Warren Buffett, who called the ratio "the best single measure of where valuations stand at any given moment".

How do you know if market risk is on or off? ›

The Bottom Line. Risk-on risk-off is an investment paradigm where asset prices reflect changes in risk tolerance. Risk-on environments thrive with expanding corporate earnings and an optimistic economic outlook. Risk-off environments occur under slowing economic data and uncertain market sentiment.

What is Buffett Indicator for USA? ›

According to the Buffett Indicator, the United States is expected to see a modest 0 percent annual return. These projections provide insights into the varying expected performances of developed economies based on the Buffett Indicator's assessment.

What is Buffett risk? ›

Warren Buffett's quote, “Risk comes from not knowing what you are doing,” encapsulates a fundamental principle of investing and decision-making.

What if the Buffett Indicator is too high? ›

Another metric, the Buffett Indicator, created by the illustrious Warren Buffett, takes the value of all public US stocks (via the Wilshire 5000 index) and divides it by Gross Domestic Product. If the result of this fraction is greater than one, it means the stock market is overvalued.

Which indicator has highest accuracy in stock market? ›

Which indicator has the highest accuracy? The Moving Average Convergence Divergence (MACD) indicator is often considered one of the most accurate technical indicators. That is because it uses a combination of moving averages to spot potential buy and sell signals.

What is the most accurate indicator for day trading? ›

Seven of the best indicators for day trading are:
  • On-balance volume (OBV)
  • Accumulation/distribution (A/D) line.
  • Average directional index.
  • Aroon oscillator.
  • Moving average convergence divergence (MACD)
  • Relative strength index (RSI)
  • Stochastic oscillator.

What is the Buffett recession indicator? ›

The Buffett indicator measures the ratio between a country's stock market cap and its GDP, and can be a valuable measure of when a country's markets are overvalued or undervalued.

What is the Buffett Indicator 200%? ›

If the ratio approaches 200%–as it did in 1999 and a part of 2000–you are playing with fire". Buffett's metric became known as the "Buffett Indicator", and has continued to receive widespread attention in the financial media, and in modern finance textbooks.

How do you use the Buffett Indicator? ›

It is calculated by dividing the stock market cap by gross domestic product (GDP). The stock market capitalization-to-GDP ratio is also known as the Buffett Indicator—after investor Warren Buffett, who popularized its use.

What is the fair value of the Buffett Indicator? ›

Also, the market may be fair valued if the ratio falls between 75% and 90%, and modestly overvalued if it falls within the range of 90 and 115%. The stock market capitalization-to-GDP ratio is also known as the Buffett Indicator—after investor Warren Buffett, who popularized its use.

How do you analyze stocks like Warren Buffett? ›

Over the decades, Buffett has refined a holistic approach to assessing a company—looking not just at earnings, but its overall health, its deficiencies as well as its strengths. He focuses more on a company's characteristics and less on its stock price, waiting to buy only when the cost seems reasonable.

What does Warren Buffett look at when buying stocks? ›

Key Takeaways

Buffett also reviews a company's profit margins to ensure they are healthy and growing. Buffett prefers companies that have a unique product or service that gives them a competitive advantage. As a value investor, he seeks out stocks that are undervalued relative to the company's intrinsic worth.

How does Warren Buffett know when to sell a stock? ›

Buffett is a long-term value investor who sees volatility as an opportunity to buy at appealing levels or to take profit and sell some of his holdings if they've overshot what he believes to be a reasonable price.

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