In the December 2001 issue of Fortune, Warren Buffett wrote a landmark seven-page article introducing a crucial market metric that became renowned as the “Buffett Indicator.”
The Great Man adapted the piece from a speech he’d given that July at the annual Allen & Co. bash in Sun Valley, Idaho, privately delivered to an audience mainly comprising top CEOs. It was the legendary Fortune writer Carol Loomis who persuaded her longtime friend and interview subject Buffett to adapt and extend his remarks for the article.
The concepts Buffett presented a quarter-century ago are timeless, and they’re especially relevant today because the yardstick that he tagged as pointing to danger then looks even more ominous now.
Buffett was writing at a time when the dotcom bubble was deflating. In the piece, he identified why the drop was inevitable, and likely to continue big time. His thesis: The total value of U.S. stocks, over the long term, can’t outpace the growth of businesses as reflected in the GDP. So when the ratio of S&P 500 to national income diverts hugely from the norm, it’s bound to swing the opposite way and “revert to the mean”—though the timing of the retracement is impossible to predict. Buffett highlighted a chart in the text displaying that at the craze’s peak in March 2000, that number, now revered as the Buffett Indicator, reached a vertiginous 200%.
“The message of the chart,” he wrote, “is that if the relationship [between the total value of equities and GDP] drops to 70% or 80%, buying stocks is likely to work out very well for you. If it approaches 200% as it did in 1999 and 2000, you are playing with fire.”
Right now, the markets are riding a seldom-before-witnessed explosion in animal spirits. Since the decline prompted by the surprise start of the Iran war, the S&P 500 has rebounded over 13% to, as of April 17, notch an all-time record of 7140 (and has stayed in that realm since). Here’s the shocker: The Buffett Indicator now stands at 232%, a figure that’s around one-sixth higher than what he identified as the prepare-for-a-roasting zone.
My hero Carol Loomis provided a great service in persuading her pal to share what become justly honored as the Buffett Indicator. This evergreen measure has issued a warning on intoxication: Keep imbibing the happy talk, and you’re in for a long hangover.
