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  • Writer's pictureRobert Baharian

The Buffett Indicator Is Flashing Red

Elon Musk asked the CEO of Ark Invest about the Buffett indicator's unusually high ratio.

The "Buffett indicator" takes the combined market capitalization of all publicly traded stocks in the US, and divides it by quarterly gross domestic product. Investors use it to gauge the stock market's valuation relative to the size of the economy. In fact, Buffett praised his namesake gauge in a Fortune magazine article in 2001, calling it "probably the best single measure of where valuations stand at any given moment." He added that when the indicator hit a record high during the dot-com bubble, that should have been a "very strong warning signal" of the crash to come.

Today, the ratio is sitting at a lofty 200%, which dwarfs the ratio of the Dot-Com and Housing bubble of the 2000's and 2007.

Having said that, I plotted the long-term trend line over the Warren Buffett indicator, and even though the Housing bubble popped when the indicator reached 100%, the indicator was smack-bang on trend.

Here's what Cathie Wood thinks of the ratio in response to Elon Musk (click on the tweet to continue reading).

Christopher Bloomstran of Semper Augustus responded:

While both Cathie and Chris provide excellent arguments, the truth is no one really knows how this is going to play out. This is exactly what makes the market. One investors point of view versus another's. One will be right, and one will be wrong. Neither of them know which one, and neither of them know when.

As I pointed out earlier, this ratio, amongst other "indicators" will rise and fall. And unless we give it some context, we have absolutely no perspective.

Do I think the ratio is going to peak and the stock-market collapse? Absolutely. When? Who knows. The second and third order consequences of such events are seldom predicted. Think about the pandemic - no one was going back to an office ever again. Even though CBD's around the world have begun to re-open, the issue has not been getting people back into the office, it's that no one wants to catch public transport there, and have opted to drive back into work, which has caused enormous traffic congestion on the roads. Who predicted that?

The market is telling us the truth right now, it doesn't mean it's right. Can the market continue to climb from these levels, yes, it absolutely can. Will it correct? As sure as the sun will rise tomorrow, yes it will. The problem for investors is trying to predict this event. And the smartest people in the world can't do it, so what makes you think you can? History shows us time and time again, more money is lost in trying to predict a crisis than the crisis itself.

The market will continue to do what it does until it decides not to. And the market doesn't care what you think, so you can continue to either fight the market, or accept it and work with it. What I mean by this is control your allocations, control the frequency of your investments. The stock market is not a binary machine, that is, your choice is not that you're either in or you're out - there is a fine balance in managing your portfolio in a way that is right for you because the stock market, and any market for that matter, can remain irrational for longer than you can remain solvent trying to bet against it.

The point is, context and perspective is important. No one ever said investing was going to be easy.


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