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Warren Buffett's Market Indicator Indicates Modestly Overvalued US Market

On Monday, Berkshire Hathaway Inc. (NYSE:BRK.A)(NYSE:BRK.B) CEO Warren Buffett (Trades, Portfolio)'s favorite market indicator sank to 111.5%, down 27.1% from the March 3 level of 138.6% and 37% from the all-time high of 148.5%.


Dow craters 3,000 points on virus jitters, Fed knocks interest rate near zero

The Dow Jones Industrial Average closed near a three-year low of 20,186.52, down 2,999.10 points or 12.94% from Friday's close of 23,185.62 and approximately 1,014 points from Thursday's close of 21,200.62. Apple Inc. (NASDAQ:AAPL), the top holding of Berkshire, closed at $242.21, down 12.86% from the previous close.


U.S. cases of the novel coronavirus, also known as Covid-19, increased to 3,774 according to statistics populated by John Hopkins University. CNBC sources added that the main concern regarding the virus outbreak is an "abrupt closure of economic activity," according to KKM Financial Managing Director Dan Deming.

The accelerated fears sank markets during the day, with the Dow tanking nearly 12% and the Standard & Poor's 500 Index suffering a 7% circuit breaker at the open. The major tumble occurred despite the Federal Reserve cutting interest rates near zero and launching a $700 billion quantitative easing program.

Market is "no longer" significantly overvalued, according to Buffett's indicator

As the market continues freefalling from the Feb. 12 all-time high of 29,551.42, Buffett's market indicator tumbled below 115%, the threshold indicating significant overvaluation. Any total market cap to gross domestic ratio between 90% and 115% indicates a modestly overvalued stock market.


Based on the current valuation level, the expected market return per year over the next eight years is 1.5%, assuming a reversion to the mean market cap to gross domestic ratio of 80%. We also considered an optimistic case, where the market valuation averages 120%, and a pessimistic case, where the market valuation averages 40% as illustrated in the chart below.


Shiller price-earnings ratio also tumbles from all-time high

Yale professor Robert Shiller said in a CNBC "Trading Nation" interview last week that stocks are vulnerable right now as the virus outbreak has not peaked yet. Shiller added the coronavirus is "contagious even before it shows obvious symptoms" and that it is "harder to quarantine people in this epidemic."

Shiller's cyclically-adjusted price-earnings ratio for the S&P 500 stands at 23.6, down 6.0 points from the March 3 level of 29.6 but still 38.9% higher than the mean ratio of 17. Despite this, the implied market return according to Shiller's market valuation is 1.5% per year, on par with the expected annual return based on Buffett's market indicator.


GuruFocus' value screeners continue identifying opportunities

Despite the markets tumbling from all-time highs, value screeners like the Ben Graham Net-Net Screen, the Undervalued-Predictable Screen and the Buffett-Munger Screen still seek good investing potential for Premium members. The Undervalued-Predictable strategy and Buffett-Munger strategy have outperformed the S&P 500 benchmark for at least seven out of the past eight years.

Disclosure: No positions.

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This article first appeared on GuruFocus.