Warren Buffett’s preferred yardstick for the stock market, known as the Buffett Indicator, has surged to 171%, indicating that US stocks are overpriced and at risk of a steep decline. The famed investor has long touted this gauge as “probably the best single measure” of stock valuations. According to Buffett, a 100% reading would suggest fair valuation, while buying stocks around 70% to 80% could yield positive results. However, he cautioned against purchasing stocks when the indicator reaches the 200% mark, likening it to “playing with fire.”
The Buffett Indicator takes the total market capitalization of all actively traded US stocks and divides it by the latest official estimate for quarterly gross domestic product (GDP). Despite its popularity, this measure has its limitations. It compares the stock market’s current value with a past estimate of economic output, and GDP figures exclude overseas income, while US companies’ market caps consider both domestic and foreign operations.
The Wilshire 5000 Total Market Index, a key component of the Buffett Indicator, has surged 22% this year, with its market capitalization reaching $46.32 trillion. This rise has been fueled by investor optimism, centered around an AI boom, potential interest rate cuts, and hopes for a soft landing for the economy rather than a recession. While the Buffett Indicator proved its worth last year as it dropped from over 210% in January to below 150% by September, investors remain cautious about the current elevated reading and its implications for the stock market’s future.