- The market indicator that guides much of the investment philosophy of vaunted value investor Warren Buffett is signaling the stock market could be significantly overvalued.
One of Berkshire Hathaway chairman Warren Buffett’s favorite market metrics is flashing a warning sign.
The Buffett Indicator, which calculates the ratio of market cap of all U.S. publicly traded stocks to the country’s gross domestic product, is at the highest level in several decades, according to research from Kailash Capital Research. As of November 2024, the figure reached 230%, the highest on record, according to Kailash’s data. That type of market dynamic hasn’t been seen since March 2000 around the time the dot-com bubble burst. Back then, the market-to-GDP ratio had reached a record level of 175%.
For Buffett Indicator supporters, the gauge is a useful metric in predicting when a stock market slump might happen. If company valuations exceed total GDP, it can indicate that they aren’t creating enough genuine economic value that gets recirculated in the economy. In other words, those companies are valued higher than the actual value they create.
“There has to be actual, real economic profits in order to justify valuations,” said Matthew Malgari, one of the report’s authors. “The data is unforgiving,” he and coauthor Sanjeev Bhojraj warned.
The metric is especially useful in Buffett’s eyes for gauging the current valuations of companies—are they too high, too low, or just right? If they are too high, as the Buffett Indicator would currently suggest, then investors should expect paltry returns in the stock market. Buffett outlined his views on the matter in a 1999 Fortune interview.
“You need to remember that future returns are always affected by current valuations and give some thought to what you’re getting for your money in the stock market right now,” Buffet said.
His point was that overpriced valuations, even of great companies, could still lead to slim investment returns by dint of the fact that an investor might not be buying at the optimal price.
Dot-com warnings
Prior to the dot-com bubble of the mid-to-late 1990s, the market was also heavily concentrated, with the market cap of the top 50 companies at 74% of GDP. In comparison, the market cap of the top 50 stocks was 110% of U.S. GDP at the start of November 2024, according to Kailash’s data.
Over the next decade following the dot-com bubble, the stock market returned -17%, per Kailash’s calculations. For the firm, the current state of play spells similar dangers for investors. Moreover, in the current state market valuations are not just too high, but overly concentrated among America’s largest companies.
Still, though market cap-to-GDP is instructive, it is not a perfect metric because it fails to account for the fact that many companies in the U.S. stock market sell their goods and services abroad, according to BCA Research chief strategist Dhaval Joshi.
“The one slight flaw or problem with the measure is that if the companies in the market cap [total] are global companies, which of course they are, then it's a sort of a mismatch because you’re looking at the market capitalization of global companies versus U.S. GDP, effectively total sales in the United States,” Joshi said.
Malgari and his coauthor, Sanjeev Bhojraj, conceded this is a valid criticism and that running the same analysis on a global scale would illuminate whether these market dynamics are the new normal for the global economy or an aberration specific to the U.S.
However, they said the criticism also reinforces their overall point that these companies are overvalued; just as global trade can provide tailwinds, so too can it provide headwinds. Many of the largest firms—especially in tech—face fierce competition from companies in other parts of the world that could threaten their dominance. For example, Tesla and Apple’s main competitors are BYD and Huawei, two companies from China, Bhojraj noted.
“If you really think about a global economy, you should also be thinking about global competition,” he said.
Malgari and Bhojraj feel the evidence is clear. “Others are welcome to continue fighting with arithmetic truths, but we are not,” the two wrote in their report.
Though, there are some key differences between the current state of the market and that of years past. The financial might at the very top of the market, such as the Magnificent Seven megacap tech stocks, is unprecedented. For example, Apple generated over $108 billion in free cash flow in fiscal 2024 and, as of its latest earnings report, Alphabet had $93 billion in cash on hand.
“The technology companies tend to have really strong balance sheets and really earnings are quite stable and not as cyclical as in the past,” said Jose Torres, senior economist at Interactive Brokers, a brokerage firm in Greenwich, Conn.
Torres added that technology is now much more integrated into all facets of life, having been widely adopted by both people and companies. For tech companies at least, they have ample room to continue growing.
“Technology is becoming a significant growth driver, while back then it was just starting,” Torres said. “Now it's sort of in everything we do so that, for that reason, this level of concentration isn't as worrisome as in the past.”
The advent of AI would seem to only strengthen the hands of the major tech companies that drive much of the soaring valuations. Still, Buffett warned back in 1999 that a specific technology boom wouldn’t automatically translate into stock market gains. At the time, he pointed to two revolutionary technologies of the 20th century as evidence: automobiles and airplanes. By 1999, roughly a century after their invention, they had not yielded a noteworthy stock market darling, despite how widespread the technologies were.
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage,” Buffett said.
Investors will ask AI companies what they previously did of airplane and car manufacturers: turn gargantuan investments into even larger profits, according to Malgari. “It’s actually almost a perfect analog because somebody has to figure out how to make huge returns on capital to justify what's going on right now,” he said.
As the Buffett Indicator continues to creep up, Buffett's conglomerate Berkshire Hathaway exited some of its most profitable investments in single companies such as Bank of America and Apple, building up a historically large cash position in the process.
That has some investors wondering if the Oracle of Omaha does, in fact, know something they don’t.
