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Warren Buffett's favorite indicator hints that stocks are significantly overvalued

Brian Sozzi
·Editor-at-Large
·2 min read
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If you are a Warren Buffett investing disciple, then you may want to consider raising some cash by selling a good number of winning positions.

Because the Oracle of Omaha’s favorite stock market indicator is looking frothy, to say the very least.

The “Buffett Indicator” as it’s called in Wall Street circles — which takes the Wilshire 5000 Index (viewed as the total stock market) and divides it by the annual U.S. GDP — is now at a record high amid the latest climb to records in the broader market. In doing the math, the Buffett Indicator stands at about 194% — up markedly from 175% or so when applying third quarter GDP data.

The figure is well above the 159.2% seen just before the dot.com bubble.

“The stock market is significantly overvalued according to the Buffett Indicator,” said researchers at GuruFocus. “Based on the historical ratio of total market cap over GDP (currently at 194.6%), it is likely to return -3% a year from this level of valuation, including dividends.”

August 30th 2020 - Warren Buffett celebrates his 90th birthday. He was born in Omaha, Nebraska on August 30th 1930. - File Photo by: zz/Dennis Van Tine/STAR MAX/IPx 2017 12/14/17 Warren Buffett at the premiere of "The Post" held on December 14, 2017 in Washington, DC.
August 30th 2020 - Warren Buffett celebrates his 90th birthday. He was born in Omaha, Nebraska on August 30th 1930. - File Photo by: zz/Dennis Van Tine/STAR MAX/IPx 2017 12/14/17 Warren Buffett at the premiere of "The Post" held on December 14, 2017 in Washington, DC.

The Buffett Indicator rose to fame after a 2001 Fortune Magazine article written by Buffett and long-time Fortune writer/Buffett insider Carol Loomis.

“The ratio has certain limitations in telling you what you need to know. Still, it is probably the best single measure of where valuations stand at any given moment,” explained Buffett in the article.

It really shouldn’t be a surprise to see the indicator as inflated as it is today.

Federal Reserve liquidity continues to run rampant and is fueling new record highs in the stock market. Meanwhile, the ongoing COVID-19 pandemic continues to depress economic output.

Get more insight on Buffett’s investing do’s and don’ts here.

Brian Sozzi is an editor-at-large and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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