Buffett indicator

Buffett indicator

10.11.2021, 12:32

The Buffett indicator, which shows the adequacy of the stock market assessment to the size of the country's economy, is breaking records again. But this does not mean that there will be a catastrophic collapse of markets.

Let's see if you need to invest now.

Record again.

By the end of October 2021, the Buffett indicator, calculated as the ratio of the market value of US domestic companies to the size of the country's economy (GDP), exceeded 225%. Theoretically, if the figure exceeds 100%, the stock market is allegedly considered overvalued, and investment is associated with increased risk. Different services give excellent estimates of the "Buffett indicator", this is due to the basis for calculating GDP and the composition of securities to account for market capitalization. But the result is one - the indicator indicates a multiple excess of market capitalization over GDP, which may suggest unbridled optimism of investors.

If we consider capitalization as an assessment by investors of future performance of corporations, and GDP - as the actual strength of the economy, the "Buffett indicator" can be interpreted as expectations of future return on investment based on current macroeconomic realities. And, as we see from Buffett, they are inflated. Even at the peak of the panic in March 2020, the "capitalization / GDP" indicator did not fall to 100%. Buffett himself, despite his GDP orientation, has been actively involved in filling and managing his portfolio of shares, which has expanded from $ 56 billion at the beginning of 2010 to $ 300 billion by September 2021.

The secret of growth.

The reason for the rise of the Buffett indicator to 225%, and hence such a significant discrepancy between capitalization and GDP, is the large-scale fiscal and monetary driver of the US financial authorities. Zero funding rate and monthly redemption of debt securities from the market provide liquidity of the financial system and conditions for inflating stock bubbles. On the GDP side, the economy has strengthened significantly since the 2020 lockdown. However, inflationary pressures and stagnation of business activity in industry in the second half of 2021 indicate that investors underestimate the future risks of slowing down macroeconomic indicators. This means that the premium, expressed in the high capitalization of the stock market, may begin to decline.

When answering the question

about the suitability of the Buffett method for the choice of investment time, there are several considerations: Imitation of the "Buffett indicator", of course, can protect against risky transactions, but then there is no question of increased profitability. The bar has been passed 100% long ago, and extraordinary shocks worse than the March 2020 collapse are needed to achieve it. Moreover, players who use short selling only on the basis of such overvaluation may face a very long-term market irrationality, risking losing their liquidity.

Buffett himself is quite scrupulous in choosing objects for the portfolio, although he constantly criticizes the general swelling of the stock market.


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