The Buffett Indicator is a widely used tool for the valuation of US stocks. In a 2001 interview with Fortune, Buffett stated that “It is probably the best single measure of where valuations stand at any given moment.”
When I think of the Buffet Indicator, I think of it as a “national price-to-earnings ratio”. Instead of using the price of an individual equity in the numerator, the Buffet Indicator uses the market capitalization all stocks in the U.S. at a point in time.
The numerator that is often used is the FRED designation for Line 41 in the B.103 balance sheet (Market Value of Equities Outstanding/NCBEILQ027S), available on the Federal Reserve website. You can also use the Wilshire 5000 Total Market Index, which is considered to be the broadest measure of U.S. stock market values.
The denominator is simply Gross Domestic Product (GDP), a national income figure.
Buffet Indicator = Market Cap of U.S. Equities ÷ GDP
As of May, 2018, the Buffet Indicator stands at 142.10%, which is the second highest value since 1950 to the present. The chart above is provided by Doug Short, PhD of Advisor Perspectives.
Although the Buffet Indicator should not be used to make short – term investment decisions, it should give you a sense of what inning we are in the current bull market. Based upon the latest reading, it should seem obvious that we are closer to the 9th inning than the 1st inning.
This guest post was written by Thomas McDevitt, CFA, CFP, EA. All opinions are his own. The above references an opinion and is for educational purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice prior to making investment decisions.