With US stock indices hitting new highs again this week, one of Warren Buffett’s most famous quotes comes to mind: Investors should “be scared when others are greedy.”
Any Buffett disciple who fixes on the billionaire investor’s favorite market valuation metric these days may have the urge to scream in terror.
The “Buffett gauge” is a simple relationship: the total market capitalization of US stocks divided by the total dollar value of the nation’s gross domestic product. It first crossed its previous peak of the dot-com era in 2019. Still, it has been trending up for decades, and if there is one mantra investors love even more than Buffett’s, it is “the trend is their friend”.
Yet in recent weeks, even that long-term trend fails to justify the metric’s frothy appearance. With us Market cap More than double the estimated GDP level for the current quarter, the index has risen to the highest reading above its long-term trend, according to a blog analysis. Current market valuation, suggesting a “strongly overvalued” situation.
Of course, with the Federal Reserve holding rates near zero and buying bonds for the foreseeable future, and an abundance of savings and fiscal stimulus to unleash blockbuster growth in GDP and corporate earnings, it’s fair to wonder if this is another. of the many. false alarms that have been sounded for the last decade.
“It highlights the remarkable mania we are witnessing in the US stock market,” said Michael O’Rourke, chief market strategist at JonesTrading. “Even if you expected those (Fed) policies to be permanent, which they shouldn’t be, it still wouldn’t justify paying twice the 25-year average for shares.”
This separation of the Buffett indicator from its long-term trend joins a variety of other valuation metrics that have outperformed their previous records in the pandemic-induced bear market rebound last year, if not years earlier. Price-to-earnings, price-to-sale, and tangible price-to-book value are among the metrics firmly above dot-com era levels that many investors assumed were once-in-a-lifetime peaks.
Rising valuations is a bad tool for timing market peaks. In fact, all tools are. For now, many investors are confident that the pandemic recovery will boost some of the denominators in ratios like these, so they are not letting valuations scare them away. The S&P 500 gained 1.2% for the week to close at a record high amid a rebound in vaccine distributions and the progress of a new fiscal stimulus package. Energy, the sector with the best performance this year, led the advance, adding 4.3%.
Meanwhile, the yield on 10-year Treasuries hit 1.20% on Friday, the highest since the crisis triggered by the pandemic last year. Interest rates are unlikely to approach a level that would undermine the bullish argument for stocks, given that the S&P 500’s earnings yield is 3.1%. Speaking to the Economic Club of New York this week, Fed Chairman Jerome Powell re-emphasized that the central bank’s stimulating policies will not pick up anytime soon.
“When compared to the fixed income markets, and at the rates they are at, the earnings performance of stocks is still positive,” he said Anu Gaggar, Senior Global Investments Analyst at Commonwealth Financial Network. “And now, with the Fed keeping rates at these low levels, that just gives the market comfort.”