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The Buffett Indicator
- chrisblackwell 5y agoJust a reminder that a larger portion of today's market value is made up from Tech stocks. Tech stocks are typically higher valuations and P/E multiples, giving a skewed data point perspective vs. 20 years ago.
- dbs 5y agoSame can be said of market valuation in 99/00. And just like at that time people are looking for adjusted valuation measures and all type of excuses to justify unrealistic growth expectations. Like ALL previous bubbles it will end in tears.
- lotsofpulp 5y agoDid the companies of 99/00 have many years of profits anywhere near the companies of today?
- plater 5y agoCisco and Ericsson did.
- lotsofpulp 5y agoI see Cisco with a few years of 15% net income profit margin from 1998 to 2000 (they do not have any reports before that on their website). And Ericcson is in the single digit ranges around 7%. Cisco actually got more profitable and since at least 2006 has been in the 20% range. Apple has been in 20%+ range for over a decade, Alphabet in the 25% range, Microsoft is hitting 30% regularly, and Facebook is at nearly 40% for the last 5 years. For Amazon, I can only assume investors are factoring in huge profit margins for AWS since it seems to be singlehandedly marching Amazon’s profit margins from near 0% to 6% in the last 6 or 7 years. Feels like a different level of profit than in previous decades.
- aazaa 5y agoMarket excesses are always marked by a "hot" sector. Remember the Nifty 50? https://en.wikipedia.org/wiki/Nifty_Fifty https://en.wikipedia.org/wiki/Nifty_Fifty The members of that group were the tech giants of their time. Replace "large-cap" with "tech" in that article. Rinse and repeat.
- neltnerb 5y agoSo you are arguing that the market is overvalued -- because tech stocks are overvalued? Makes sense, perhaps the apparent overvalue is simply because of companies like Uber and Tesla.
- codingdave 5y ago> Tech stocks are typically higher valuations At the end of the day, stocks are worth whatever people pay for them. It is a fact that tech stocks do have higher P/E multiples at this moment in time. The important question for investors is whether those multiples mean that the stocks are overvalued... or whether they deserve it. The market will decide that, and the answer may change drastically just like any other set of stocks.
- mmmmkay 5y agoThis doesn't take into account interest rates. Buffett himself has said recently that given the current interest rates stocks are not overvalued.
- mmmmkay 5y agonvm, just got to the "Criticisms of The Buffett Indicator" section where they cover just this topic :)
- danielmarkbruce 5y agoThey don't cover the % of revenue derived from overseas. Ie the GDP of the US is less meaningful over time for the S&P 500. It really should show total market cap / GDP of relevant jurisdictions weighted.
- plater 5y agoI don't think you are wrong, but then some of the US GDP belongs to other countries so there are also some deductions to do.
- danielmarkbruce 5y agoYup, I guess the MSCI 1500 (or similar) / global GDP is probably easiest.
- betterunix2 5y agoOn the other hand it is not likely that interest rates will remain this low for very long. How much money can be poured into 30 year bonds with less than a 2% coupon rate? How long will the Fed continue its asset purchase program? How much more supply can be added to the bond market before demand begins to run out? One way or another interest rates will begin to rise, and then the stock market will be forced to correct. We have had a 40 year bull market in bonds, but that is almost certainly coming to an end. There is just no more room for that bull to run.
- ethbr0 5y agoThe problem with macro-economic composites is that at that level, everything is unfolding on different timescales. So around transitional moments, your end result is going to go wonky. GDP plummets -> interest rates are dropped -> GDP recovers -> interest rates are raised You're balancing between responsiveness, accuracy, and reliability: pick two. I'd have thought the last few crises would have taught us that we should be thinking about the system more in terms of stability, or lack thereof. The housing crisis could have not exploded, if key institutions and/or investors had acted differently. But it was objectively true that the entire system was in a very unstable state.
- bumby 5y ago>You're balancing between responsiveness, accuracy, and reliability: pick two. Can you explain the difference between accuracy and reliability in this context?
- planet-and-halo 5y agoNot OP, but I imagine it's something like "precision" vs. "how often correct." So you can be extremely precise quickly, but not all the time. Or you can be extremely precise all the time, but not in time to make good decisions. Et al.
- jbay808 5y agoI'm increasingly of the opinion that control theory is the right framework to apply here. The very existence of business cycles suggests that the economy has "underdamped poles", and perhaps a more forward-looking central bank policy could add enough phase margin to damp them and prevent recessions altogether. But it would require always taking one's foot off the gas pedal before conditions really seem good enough.
- bildung 5y agoYou may like Keynes :) Some of his main points were about countercyclical fiscal policy.
- deleted 5y ago[deleted]
- aazaa 5y agoThe problem with these indicators is that, although they may indicate over- or undervaluation, they tell you nothing about when a mean reversion will happen. As Keynes famously said: "The market can stay irrational longer than you can stay solvent." An indicator that does a pretty good job of signaling the "when" of a recession, and by extension the likely "when" of large market corrections, is yield curve inversion. It predicted the recession of early 2020 quite well, even with the external shock of the pandemic. https://www.forbes.com/sites/leonlabrecque/2020/02/26/another-yield-curve-inversion-symptom-of-covid-19-or-a-recession/ https://www.forbes.com/sites/leonlabrecque/2020/02/26/anothe... From the perspective that somehow a reset of the business cycle has happened through government transfers (not exactly a sound assumption), watch interest rates, and in particular the relationship between the 2 and 10 year. Should we start to see a rise in short-term rates, without a similar rise in long rates, watch out. You'll no doubt see a multitude of articles explaining how "this time is different." It won't be. And on top of all of that, we'll head into it with the most overvalued market in history.
- hhmc 5y agoAn inverted yield curve has accurately predicted 9 out of the last 5 recessions ;) You can even see it on the chart in the linked article, in 2005/06 — that time, it was different.
- dforrestwilson 5y agoValuations have been stretched for almost half a decade now according to old market metrics. All of these valuation metrics were originally derived when actively managed mutual funds ruled the roost. Passive ETFs are imposing an entirely different trading/investing ruleset on the system. This should not be underestimated.
- sfblah 5y agoNo matter what mechanism is used, investing comes down to putting money into a instrument to get a reasonable level of return given the risk taken. Passive investment strategies don't change this fundamental equation; they just hide the mechanics from the investor. The $64 questions in today's economy are: 1. Will multiple expansion continue indefinitely, thereby enabling investors to achieve higher profits than one would expect via fundamentals alone (GDP growth, profit margins, tax rates)? 2. Is the risk in the index really so low that it makes it worth an investment, even if the return absent multiple growth is something like 3-4% a year nominal? 3. When risks do emerge, can the federal government indefinitely reward investors with lower discount rates without triggering any negative consequences? None of these is directly tied to passive investment. In fact, I'd argue the fact that investors no longer actively track what's going on in indexed portfolios creates a benign neglect situation that is contributing to the current bubble and the risk of collapse. My biggest concern here is that the bubble is so large that, if it collapses and the government stops being able to print money to "correct" that, even those with marketable skills and decent savings won't be able to escape the undertow of the recession/depression that follows.
- nly 5y ago#2 depends on time horizon. Getting 3% above inflation is better than losing ~2% per year to inflation. With the former, over 30 years, you're doubling your purchasing power. Over 30 years you'd be very surprised and unlucky not to make a positive return with a globally diversified stock portfolio
- H8crilA 5y agoThere are much, much better ones: 1) Philosophical Economics' stock/bond/cash preference model: http://www.philosophicaleconomics.com/2013/12/the-single-greatest-predictor-of-future-stock-market-returns/ http://www.philosophicaleconomics.com/2013/12/the-single-gre... https://financial-charts.effingapp.com/ https://financial-charts.effingapp.com/ 2) John Hussmann's non-financial market cap to gross value added: https://www.hussmanfunds.com/category/comment/ https://www.hussmanfunds.com/category/comment/ https://www.hussmanfunds.com/comment/mc210715/ https://www.hussmanfunds.com/comment/mc210715/ But as the sibling comment and all the sources above say, those do not predict the path, only the destination (which is a decade or more in the future). It would be completely consistent with such macro valuation models if, for example, the general prices doubled or even quadrupled over the next year or two, why not. Stay safe out there :)
- gpt5 5y agoThese indicators are far more interesting and useful than crash/recession predictions. Being so highly correlated with subsequent market returns makes your choice simpler - you don't need to predict the crash, instead you can simply see your estimated returns in the next decade (currently negative). Whether the crash comes tomorrow or in 5 years is meaningless.
- dhsysusbsjsi 5y agoNow divide by M1 money supply. Is it the stock market over valued or the dollar devaluing as they print trillions of them.
- kbutler 5y agoI wondered about this too, but both sides of the ratio are denominated in current dollars, so dollar valuation is already divided out: ratio of total US stock market value to US GDP
- DickingAround 5y agoThere's just one more step; the market's value is an expectation of the future while the GDP is a 'now' metric. So while inflation is auto-adjusted (roughly) in the past, a strong expectation of inflation now can send the market cap up (and either GDP will catch up, be it natural or on inflated dollar terms) or the market will crash, or some combination of the two to bring the indicator back to earth.
- eloff 5y agoI don't think that's correct. Stocks suffer with inflation. Interest rates rise and money moves to bonds. Credit is costlier and profits fall. Both weigh on stock prices. Historically stocks perform poorly in times of high inflation.
- jpalomaki 5y agoMaybe inflation is not hitting these at the same pace? The money supply has been increasing for already some time, but only now we are seeing inflation catching up for example on consumer prices. For money supply to show in consumer/business side of GDP, money created by central bank need to be distributed. When interest rates have been low, maybe banks were hesitant to start pushing money to individuals and businesses and it instead ended up in stock market.
- carnitine 5y agoThe central bank performing a duration swap on money already in the economy does not involve printing anything. They’d like you to think it does though as fear of inflation stokes the behaviour they want.
- deleted 5y ago[deleted]
- julienchastang 5y agoRelated to all of this, note, we may see in the not too distant future "deeply negative" interest rates. Currently, it is difficult to go much below zero because you can stash physical bank notes under your mattress and get a better rate of return (0% instead of -1). But in a cryptocurrency future, the mattress is not an option enabling central banks to go deeply negative (e.g., -5%). I just read a fascinating article in the WSJ about this topic: https://www.wsj.com/articles/digital-currencies-pave-way-for-deeply-negative-interest-rates-11631091581 https://www.wsj.com/articles/digital-currencies-pave-way-for...
- jbay808 5y agoYou can actually create negative interest paper bank notes without needing cryptocurrency. One example is stamp scrip, where one must pay a recurring fee to maintain the note's validity: https://en.m.wikipedia.org/wiki/Scrip#Stamp_scrip https://en.m.wikipedia.org/wiki/Scrip#Stamp_scrip
- californical 5y agoIsn’t that what we have inflation for though, essentially? It’s basically just an annual ~2% tax on cash (with some volatility)
- autosharp 5y agoThe central bank only sets interest rates directly, but not inflation.
- deleted 5y ago[deleted]
- zcbenz 5y agoIs Buffett indicator still relevant today with deep globalization? It does not take account of at least following factors: * Companies like BABA or SE that contribute little to US GDP. * Tech giants shift profits to low-tax countries. * Income from US only makes part of global giants' income. (I know almost nothing about economy so this is novice question, instead of a statement against the effectiveness of Buffett indicator.)
- winstongator 5y agoI agree with this. Apple, a huge part of spy, does tens of billions of business outside the US. Most of the rest of the S&P 500 also. Using US GDP as a denominator is faulty when the stocks in the numerator are worldwide leaders. It’s a simplistic measure that I wouldn’t base my investments on.
- kbutler 5y agoI think this is the biggest factor - the rise of the "Buffett Indicator" implies that the stock market is increasingly valuable compared to US GDP, and thus capturing or measuring more value than just US production, but the linear expectation suggests a constant rate of globalization, with no justification.
- mewpmewp2 5y agoI'd think this and everything Buffet used to do is obviously outdated. Any simplistic indicator or metric won't be more accurate than what a current market cap for the company is as financial companies, with state of the art tools, researchers and experience can determine what is accurate with far more efficiency than Buffet or any simple metric ever could. If they realise there's inaccuracy in a market cap somewhere, and there's reason to believe that the market cap will change in some direction, they will take the profit from it until there's nothing to take and market cap will be accurate again according to their calculations. Even if in some cases they might be wrong, they will be more accurate in the long run as any usual metric due to law of large numbers. Essentially when trying to use any indicators or metrics here you are playing poker against people who have far more information about the cards compared to what you have.
- dustintrex 5y agoAll dollar-denominated graphs in the article use linear scales, which is misleading, because price inflation is compounded (exponential). Compare the difference in how steady inflation looks between linear (left) and logarithmic (right) here: https://www.graphpad.com/guides/prism/7/user-guide/images/embim7.png https://www.graphpad.com/guides/prism/7/user-guide/images/em... This is not to dismiss the fact stock market valuations are outstripping growth of the economy, but the article is definitely making it look even worse than it is.
- dannyw 5y agoThe chart here is a ratio. Both the numerator and denominator are the same unit, so it doesn't matter if the unit inflates.
- dustintrex 5y agoYes, the first chart is a ratio, but Figures 1 and 2 immediately following it are not.
- sb057 5y agoI would just like to point out the fact that the S&P 500 is almost four times higher capitalized than it was a decade ago. There are three obvious reasons for this that come to my mind: * There has been massive asset inflation. * The market is in a speculative bubble. * The 500 largest American companies really are ~4 times more valuable than they were 10 years ago. Even with #3, the best case scenario, that alone should be setting off major alarm bells, because their material contribution to society hasn't increased fourfold, so that increased valuation must be coming from somewhere, that is to say, control over society more generally.
- Iv 5y ago> their material contribution to society hasn't increased fourfold, If their contribution to the top 1% increased 400-fold, does that balance out?
- autosharp 5y agoAs OP said, > that alone should be setting off major alarm bells No I don't think that balances out unless you think the 1% is much more important than the rest of society.
- pfortuny 5y agoSaving is worthless is another reason. (I have said this above, though): if money today is worth less than money tomorrow, you want to get rid of it as fast as you can. People want to "save", anyway. This implies that the only way to save money is to invest it in risky assets. There is no point in buying bonds as investment for the general investor (only for hedging) if they will be worth less tomorrow than today -you are burning money, literally. Does this not look very much like inflation? (i.e. if you do not spend your money _right now_ you may not be able to buy anything tomorrow)..... It is inflation but Central Bankers do not want to see it.
- mewpmewp2 5y ago4. We could be very soon reaching productivity explosion. You might think it's 2., but market has to account for that.
- lugged 5y agoDoes usage of this account for money supply variation? If you're printing away the value of a dollar this will inevitably get larger no matter what.
- jyriand 5y agoThe heuristic that market crashes every ~9 years seems to work well. 2020 had a pretty steep correction, so I will wait another 7 years and start worrying. That might not be optimal, but 70% of the time you can predict the weather by saying it will be the same as yesterday.
- Iv 5y agoIt took me a while to understand that market valuation should not be linked to GDP, but to the integral of GDP. Every year, companies add a portion of the GDP to their overall value.
- nly 5y agoNot all markets are overvalued. The US market (e.g. s&p 500) is only half of the global market by market cap.
- pcurve 5y agoYep, all the old unsexy stocks are still trading at fair valuations.
- pfortuny 5y agoAs long as interest rates are essentially <=0, no coefficient or ratio which does not take that into account is useful. Breaking the concept of money as value in time (and that is what the ineterest rate means, because value now is better than value later) has broken all the basics of economics and finance. And is totally distorting. It is a huge shame which central bankers somehow will have to pay for. Edit: just to explain. "Value now" is better than "value later" or otherwise actions are generally worthless, which is a somewhat negative philosophical foundation for "Economy" which comes from "household management"...
- nlitened 5y ago> It is a huge shame which central bankers somehow will have to pay for. You surely mean that central bankers will have to pay nothing, and poor people will pay.
- belter 5y agoCentral Bankers will argue they did not know how the Economy works. They were able to pull off that one before: "Greenspan - I was wrong about the economy. Sort of" https://www.theguardian.com/business/2008/oct/24/economics-creditcrunch-federal-reserve-greenspan https://www.theguardian.com/business/2008/oct/24/economics-c... "‘I made a mistake,’ admits Greenspan" https://www.ft.com/content/aee9e3a2-a11f-11dd-82fd-000077b07658 https://www.ft.com/content/aee9e3a2-a11f-11dd-82fd-000077b07... "Greenspan: I was wrong about the economy" https://youtu.be/XQFq97ljy3k https://youtu.be/XQFq97ljy3k "Greenspan Says I Still Dont Fully Understand What Happened" https://youtu.be/R5lZPWNFizQ https://youtu.be/R5lZPWNFizQ "Alan Greenspan, ''Savant Idiot''" https://www.forbes.com/2008/10/24/alan-greenspan-idiot-oped-cx_mt_1024thomas.html?sh=6affb82c4fe3 https://www.forbes.com/2008/10/24/alan-greenspan-idiot-oped-...
- belter 5y agoIn case you are wondering the current Fed chairman is considered a Greenspan admirer: "Powell’s Homage to Greenspan Hints at a Fed Flashback" https://archive.is/Fk5Ou#selection-2695.0-2695.53 https://archive.is/Fk5Ou#selection-2695.0-2695.53 "Jerome Powell Channels Alan Greenspan in Putting Stamp on Fed" https://archive.is/R90mw#selection-3027.0-3027.61 https://archive.is/R90mw#selection-3027.0-3027.61 "Fed Chairman Jerome Powell makes no secret of his admiration for Alan Greenspan—and now his actions looks a lot like his predecessor's" https://twitter.com/business/status/1303641312693039105 https://twitter.com/business/status/1303641312693039105
- greesil 5y agoI thought for sure we were headed for a recession prior to covid based on this. The great thing about being a permabear is that eventually you are right. In the meantime you're a terrible investor who can't afford to buy a house. And then when your predictions are fulfilled, the prize for winning is everything going to crap in the world
- amelius 5y agoYou can invest in put options.
- plater 5y agoWell if the bear does not come then a put option is useless. That's the problem OP has by being a bear.
- mewpmewp2 5y ago> The great thing about being a permabear is that eventually you are right. No guarantees. Even if a significant crash in the future happens, there's no guarantee it would even remotely reach the level we are at now. I'm not saying "this time it's different", I'm saying it's always possible that "this time it's different".
- JumpCrisscross 5y agoThis indicator is sensitive to a number of financial factors, including corporate capital structure (higher if companies finance with equity over debt) and IPO rates (higher if companies go public faster than public companies fail or go private). Given both those have been highly variable in recent years, I’d argue this measure has receded in value as a metric.
- mrkramer 5y agoI respect Buffet Indicator but small and medium sized businesses are not part of US stock market so it is somewhat irrelevant to compare GDP to Stock Market Value if you do not include approximated valuation of small and medium sized businesses.