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Thu Aug 20, 2020, 10:49 PM

Warren Buffett's favorite stock market indicator reaches internet bubble extreme

Warren Buffett's favorite stock market indicator reaches internet bubble extreme , Yahoo Finance, 8/20/20

The ‘Buffett Indicator’ as it’s called in Wall Street circles — which takes the Wilshire 5000 Index (viewed as the total stock market) and divides it by the annual U.S. GDP — is at its highest level since before the internet bubble crash in 2000. Currently, the ratio of 1.7 is some 70% above its historical average of one.

Back before the internet stock crash, Current Market Valuation points out the ratio stood at 1.71 — or the market being 71% overvalued.

“Normally, this ratio is around 1, meaning that total market cap of all U.S. stocks generally equals annual U.S. GDP. When stocks are considered to be fundamentally overvalued, the ratio increases to 1.3 (so total stock market capitalization is 30% larger than U.S. GDP),” explains Sevens Report Research founder Tom Essaye.

More: https://finance.yahoo.com/news/warren-buffetts-favorite-stock-market-indicator-reaches-internet-bubble-extreme-165447233.html

In short, currently it's virtually at the same level, 1.70, as it was before the dot com crash, 1.71

I've never been a big fan of valuation measures of the market since all the well-known ones, including the Buffett indicator, ignore the interest rates that one can earn on fixed income investments like bonds, which compete with stocks. Interest rates today are lower now (and that was true too pre-Covid) than they were back in 2000 and 2007 before the big crashes. People naturally gravitate towards stocks more than they did in the past, unwilling to settle for 2% on bonds.

However, the valuation metrics are getting rather extreme, and I can't just blow them off forever. Particularly since the low interest rates are deliberately artificial -- by the Fed reducing the Fed Funds rate to zero, and by buying massive quantities of both Treasury bonds and corporate bonds to push their prices up (and thus their yields down).

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Reply Warren Buffett's favorite stock market indicator reaches internet bubble extreme (Original post)
progree Aug 2020 OP
unblock Aug 2020 #1

Response to progree (Original post)

Thu Aug 20, 2020, 11:05 PM

1. i agree that it's not wise to read too much into any one metric,

but the point of a valuation metric is that one way or another they tend to revert to the mean. these levels are unsustainable. the question is how does it revert to the mean.

the obvious way is for prices to simply crash, but that's hardly the only way. they can come down slowly, or gdp can come up to close the gap.

the other "way out" is that maybe it doesn't revert to the mean, maybe things shift to a consistently higher corporate valuation level. this could be possible if public companies in the aggregate become more profitable than they have historically been. remember that the stock market isn't really a measure of the economy, it's a measure of corporate profitability among public companies. which is certainly highly correlated with gdp, but not absolutely so.

corporations have become more monopolistic and have been extracting rents to a greater degree than they had been in the past. in other words, corporate profits as a percent of gdp has increased, meaning that a higher valuation may be warranted.

some of it is just concentration. if the largest 5000 stocks represent a greater share of gdp than the largest 5000 did in the past, then sure, they justifies a higher valuation.

now, 70% over the historical average valuation? that, i can't say....

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