What Does the Buffett Indicator Tell Us About U.S. Equity Valuations?

January 20, 2017 | ,

As markets continue to reach new all-time highs many investors are wondering how much more runway is left for the current 8-year bull market. While different valuation metrics will tell different stories, it can be helpful to look at what Warren Buffett has dubbed the single best measure of long-term market valuations.

For this week’s chart of the week, we take a look at the “Buffett Indicator” which consists of the Wilshire 5000 index market cap divided by the quarterly nominal GDP of the U.S. economy. As of the third quarter, the reading stood at 121%, just below its two decade high and 45-year two standard deviation average. These readings would suggest that the market is overbought. However, there is no perfect market indicator, so while the Buffett Indicator can be used as a sign of caution to investors who are considering committing further funds to U.S. equities, it should not be relied upon as an exclusive predictor of future market returns. Although the Buffett Indicator suggests that valuation levels are high, positive earnings growth began to emerge in late 2016 and could provide further support for current valuations if companies can deliver on profit projections. These statistics will be watched closely as the year unfolds to gauge the future direction of the U.S. equity market.