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Buffett Indicator: Is the Stock Market Overpriced?

Written by:
PK

This page computes and graphs the Buffett Indicator valuation or stock market capitalization to GDP ratio for the United States. It provides a historical Buffet Indicator graph and current value, plus the median, minimum, maximum, and average value for the indicator.

You can use either the Federal Reserve's estimates for outstanding equity value in America or the Wilshire 5000 Full Cap Price Index crossed with the US Gross Domestic Product for an estimate.

Buffett Indicator for the United States

Buffett Indicator Tool Usage

When you first opened this page (or if you toggle the method), the tool will calculate the United States' overall stock valuation based on auto-updating data.

You only have to choose how to estimate the indicator:

  • Wilshire 5000: Use a multiplier on the Wilshire 5000 Price Index to estimate the market capitalization of companies in the US
  • Fed Estimate: Use the Federal Reserve's quarterly estimates to estimate the market capitalization of business in the United States

(Read the methodology section for information about how the two estimates are constructed.)

Once you choose a method (or are happy with the one that auto-loaded!), here are the statistics the tool will report:

  • Current: The most recently quarterly reading of the Buffett Indicator, based on your choice
  • Last Data Point: the quarter of the last observation in the tool
  • Average: The average Buffett Indicator reading, using your preferences
  • MedianMinimumMaximum: The median, minimum, and maximum reading in the index, respectively

Additionally, if you choose to use a Wilshire 5000 estimate, you'll also see two more fields:

  • Wilshire Estimated: The estimated Buffett Indicator based on the last closing date price in the tool.
  • Last Close: The most recent Wilshire 5000 closing price in the tool's dataset.

What is the Buffett Indicator?

The Buffett Indicator is a market valuation measure, also known as the stock market capitalization to Gross Domestic Product ratio. Others call it the Buffett yardstick instead.

It originated in a December 2001 interview with Carol Loomis, where Warren Buffett discussed his favorite way to quantify stock valuation on a macro level. Originally, he discussed dividing market capitalization by (the then-popular) Gross National Product.

Buffett went on to explain what various levels meant and that he expected ~7% returns at the time's 130% levels. On thresholds:

If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200%--as it did in 1999 and a part of 2000--you are playing with fire.

-Warren Buffett, 2001 Interview for Fortune Magazine

Buffett Indicator Formula

The formula for the Buffett Indicator is:

Buffett\ Indicator=\frac{market\ capitalization}{gross\ domestic\ product}

If you're doing the math for the United States manually, there are a few ways to estimate the total market capitalization. The tool here has two methods built-in: it can use either Federal Reserve estimates or work with price index values on the Wilshire 5000 – more on that below in Methodology.

Tool Methodology

Depending on your preferences, the tool will use either of the following calculations or series for the numerator:

Whichever you choose is then divided by Gross Domestic Product for the United States, released by the Bureau of Economic Analysis. (Buffett originally used Gross National Product, but note the two track each other almost exactly. GNP measures only citizen output, whether overseas or in the US. )

The tool will auto-populate with quarterly data back to the first quarter of 1952. If you choose to use the Wilshire method, it will also use a recent closing price for the Wilshire 5000 – check the box for the specific close. However, if you use the Wilshire data, note it goes back to 1975.

Questions About the Buffett Indicator

The Buffett Indicator is meant to be a quick temperature check on a market's valuation. It isn't a timing tool; it can only tell you how the market's general valuation compares to the historical norms. It doesn't say what's going to happen this week or even this year.

If the Buffett Indicator has utility, it's over a longer timeframe. In short: poor valuations can continue, and good valuations can get even better.

Does the Buffet Indicator still work? Is it reliable?

The Buffett Indicator worked in the past as a broad predictor for future returns – over a long enough period. If you match up the data we have with the S&P 500 or Dow Jones (or other large measures), you'll see that it eventually 'corrected' to a new level. How

As with any indicator (such as the Shiller PE or CAPE, or Tobin's Q applied to the full-market), broad valuation measures are perhaps a useful input but not necessarily the whole story. They may have worked historically, but unprecedented conditions – such as extended periods of low interest rates, or more globalized companies in an index – may mean indicators don't work in the same way.

Of course, when an indicator is overextended, it is the most dangerous time to say, "this time is different." So – be safe and realize things change, but also know

Is your tool using the right computation for the indicator?

Probably not exactly, but it's a good guess at Buffett's original intent. Gross National Product has fallen out of favor, but GDP is a close substitute. As for the target levels, Buffett mentioned some benchmarks in his 2001 interview:

If the ratio approaches 200%--as it did in 1999 and a part of 2000--you are playing with fire.

Some people calculate the indicator with the Wilshire 5000 and no adjustment for the market cap ratio (~ $1.15 billion according to their web site). Other folks will use a Fed estimate but leave out financial corporations. Using these methods, you get ~ 188% and 165% in 1999-2000, respectively.

But really, it doesn't matter as long as your indicators are constant and the methodology doesn't change. You need a consistent look over many market conditions if you're going to use the indicator as input.

What are good values for the Buffett Indicator?

Using the models in the tool and Buffett's historical comments here are some rough guidelines:

  • 70-80%: Good valuation
  • Up to 130%: Neutral valuation
  • 200%: Bad valuation

Remember: these are rough levels with no guarantee to be true in the future. If they apply, they will apply to a broad measure like the S&P 500.

Importantly: they would only apply for calculations similar to the ones in this tool. If you are using a different formula (especially in finding the numerator), scale Buffett's suggested values.

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