The Buffett Indicator: Reasons for Doubt

Gregory van Kipnis  – April 16, 2021 @ American Institute for Economic Research

Recently Tesla CEO Elon Musk asked Ark Investment CEO Cathy Wood about her view concerning the Buffett Indicator, which is pointing to a historic overvaluation in stocks and hence suggests a coming crash. She first insinuated that it was outdated. Then she said her team would have a closer look. 

As tempting as it is to believe that there is a simple formula out there to reveal the future of financial markets, there are good reasons for doubt. While no measure or method can be expected to be an unfailing determinant of market valuation, the reputation of the Buffett Indicator itself is likely overvalued. 

In an article in January I concluded that the S&P 500 was fairly valued. That study was based on a detailed analysis of price-earnings ratios. The conclusions rested on a proper understanding of the importance of expected earnings and dividends rather than the backward-looking Shiller CAPE ratio. I did not believe the Buffett Indicator was relevant to the analysis then because it did not focus on what matters most – earnings.

Nonetheless, there is an infatuation with this indicator, which Buffett made popular – so much so that it has reached a fever pitch. The indicator measures the ratio of the market value of publicly traded stocks to the nominal value of GDP. That is, a ratio of asset values to the value of production of all goods and services produced in a given year in the US. 

The ratio has increased dramatically to about 200% from the 40-80% range in the period leading up to late 1999............... To Read More.....