In case you don’t know the name, Warren Buffet is one of the greatest investors that has ever lived. His way of measuring whether or not the stock market is overvalued is called the “Buffet Indicator.”
What is the “Buffet Indicator”? You divide the Wilshire 5000 Total Stock Market Index by the Quarterly Gross Domestic Product (GDP). If that number is over 1.0, then that triggers some concerns of the markets being overvalued. The Wilshire 5000 Total Stock market index is a market capitalization-weighted index of every US based stock traded in the US. These are companies that are headquartered in the US and their stock is actively traded on an American exchange.
Here are some recent numbers of the Buffet Indicator:
1st Quarter 2000: 1.18
The Dotcom Bubble (Tech Bubble). The markets started falling in 2000 and the tech bubble burst from 2000-2002.
2nd Quarter 2007: 1.01
The Financial Crisis of 2008 which lasted from 2007-early 2009.
Where is the Buffet Indicator now? Buckle up. 1.78 (The highest the indicator has ever been.)
Now granted the Indicator has been over 1.0 since the 1st Quarter of 2013 and it’s been creeping up ever since indicating that the markets have been slightly overvalued.
Did this indicate the 2020 stock market crash and is there another on the way? The 2020 stock market crash is a global crash and began on February 20, 2020. The COVID-19 pandemic initiated the crash, but no one has a crystal ball to say if a crash was about to occur or if another crash is on the way. What we do know is that the Indicator does not take into effect international stocks and we are much more of a global economy than ever before. We also know that the 1st GDP number for 2020 decreased by 4.8% and the 2nd quarter is going to more than likely look worse which can skew the Indicator.
With the Indicator at an all-time high, perhaps a level of caution is the right approach when investing in this environment.
If I had some cash on the sidelines right now, would I dump it all in the stock market today? Nope. I would begin dollar-cost-averaging the money in over the course of the next year. For example, if I had a $100,000 in cash that I wanted to get back in the market, I would look at moving $8,000-$10,000 a month back in. Now is the time to be cautiously aggressive. For now a smooth and steady allocation makes sense. If we see the low’s we saw a month or so ago, then I would get more aggressive in moving the money back in and I would consider going all-in at that stage. Everyone has a different level of risk they are willing, or can afford, to take. You should understand the level of risk you can take before investing in good times or bad.
Are we setting up for a big drop? Nobody knows. Are we set to return back to the all-time high? Eventually. Both answers are clear as mud. What we do know is if you are in good quality investments and you have time on your side, you should be fine.
The signal that we’re getting from the Buffet Indicator is not a good one but that doesn’t necessarily mean we’re due for a crash. It means stocks are overvalued. Be patient, invest in quality and be cautiously aggressive and you’ll be just fine.
Live free my friends,