The Wilshire 5000 Total Market Index , known as the ‘Buffett indicator’ , compares the value of the stock market to the size of the economy.
Warren Buffett’s favorite market gauge reaches has risen to an all-time high of 195% , indicating that stocks are overvalued and we could see a sharp decline in the coming months .
This indicator collects the market capitalization of all stocks listed in the United States, and divides it by the quarterly gross domestic product. Investors use it to measure the valuation of the stock market relative to the size of the economy.
The Wilshire 5000 Total Market Index is at $ 41.89 trillion, while the anticipated estimate for fourth quarter GDP is $ 21.5 trillion.
Dividing those numbers puts Buffett’s gauge at 195%, well above the 187% level it reached in the second quarter of 2020, when GDP was roughly 10% lower, Business Insider notes .
Buffett praised his namesake indicator in a 2001 Fortune magazine article , calling it “probably the best way to measure valuations at any given time.”
According to the CEO of Berkshire Hathaway (NYSE: BRKa ), when the indicator hit an all-time high during the dot-com bubble, it should have been a “very strong warning sign” of the collapse to come.
Buffett’s preferred yardstick also skyrocketed in the months leading up to the financial crisis , making him a reliable tool for anticipating market downturns , Business Insider recalls .
However, the measure has its flaws , adds the economic publication. For example, compare the current value of stocks to the GDP of the previous quarter. Also, companies listed in the United States do not always contribute to the American economy, and GDP ignores foreign income.
The coronavirus pandemic has also disrupted economic activity and plunged GDP, inflating Buffett gauge readings over the past year. Still, stocks are expensive by almost any measure, suggesting that the indicator is not completely off the mark.