Buffett Indicator Says Markets Are Going To Crash?

“The ‘Buffett Indicator’ says the stock market will crash. Such was an email I received recently and was worthy of a more detailed discussion. Let me begin with my favorite line from “The Princess Bride.”

“I do not think it means what you think it means.”

The Buffett Indicator is a valuation measure that compares the stock market’s capitalization to the Gross Domestic Product. A favorite of Warren Buffett, the indicator sits shy of 2.44 times market-cap to GDP. That number doesn’t mean much on its own, but it’s striking when placed in a historical context. Even after the recent fall in markets, the ratio is still one of the highest on record, north of the 2.11 level recorded during the dot-com bubble of 2000, and considerably elevated compared to the average since 1950.

Buffett Indicator, Buffett Indicator Says Markets Are Going To Crash?

Since 2009, repeated monetary interventions and zero interest rate policies have led many investors to dismiss any measure of “valuation.” The reasoning is that since there was no immediate correlation, the indicator is wrong.

The problem is that valuation models are not, and were never meant to be, “market timing indicators.” The vast majority of analysts assume that if a measure of valuation (P/E, P/S, P/B, etc.) reaches some specific level, it means that: