Buffett Indicator at All-Time Highs: A Cause for Concern?
In 2001, Warren Buffett famously described the stock market capitalization-to-GDP ratio as “the best single measure of where valuations stand at any given moment.”
This ratio, now commonly known as the Buffett Indicator, compares the size of the stock market to that of the economy. A high ratio indicates an overvalued market—and as of February 11, 2021, the ratio has reached all-time highs, indicating that the U.S. stock market is currently strongly overvalued.
Today’s graphic by Current Market Valuation (CMV) provides an overview of how the Buffett Indicator has changed since 1950. We’ll also explain how the ratio is calculated, and why things might not be as dire as seem.
The Buffet Indicator, Explained
Before diving into the data, let’s cover the basics—what is the Buffett Indicator, and how is its value calculated?
The Buffett Indicator is a ratio used by investors to gauge whether the market is undervalued, fair valued, or overvalued. The ratio is measured by dividing the collective value of a country’s stock market by the nation’s GDP.
Measuring Total Value
CMV used the Wilshire 5000 index, along with data from the Federal Reserve for the historical component, to measure the collective value of the U.S. stock market. Here’s a look at the nation’s composite market value since 1950:
As the chart indicates, the market has experienced steady growth since 2010. And as of February 11, 2021, its total value sits at $49.5T.
For the data on GDP since 1950, CMV dipped into the archives from the U.S. Government’s Bureau of Economic Analysis:
While the Bureau’s data is published quarterly, it doesn’t provide the latest figures. So to find Q1 2021 GDP, CMV used data from the Federal Reserve Bank of Atlanta, and came up with an annualized GDP of $21.7T.
According to Warren Buffett, “if the ratio approaches 200%…you are playing with fire.”
And with the current U.S. ratio sitting at 228%—about 88% higher than historical averages, it certainly looks like things are heating up.
Will History Repeat Itself?
As the popular investing expression goes, the trend is your friend. And historically, the Buffett Indicator has predicted several of America’s most devastating economic downturns.
Here’s a look at some historical moments in the U.S. stock market, and where the Buffett Indicator was valued at the time:
|Date||Event||Buffett Indicator||Value (+/- Trendline)|
|October 1987||Black Monday||Fairly Valued||-13%|
|March 2000||Dotcom Bubble||Strongly Overvalued||+71%|
|December 2007||Pre-Financial Crisis||Fairly Valued||+18%|
|March 2009||Financial Crisis Bottom||Undervalued||-46%|
|February 2021||Today||Strongly Overvalued||+88%|
As the table shows, the ratio spiked during the Dotcom Bubble, and was relatively high in the months leading up to the 2008 financial crisis. But does that mean we should take the ratio’s current spike as a warning for a market crash in the near future? According to some experts, we might not need to sound the alarms just yet.
Why are some investors so confident in the current market? One main factor is low interest rates, which are expected to stay low for the foreseeable future.
When interest rates are low, borrowing money becomes cheaper, and future real earnings are theoretically worth more, which can have a positive impact on the stock market. And low interest rates mean smaller returns for low-risk assets like bonds, which lowers investor demand and ultimately boosts stock prices further. Meaning that, as long as interest rates are at record lows, the Buffett Indicator will likely stay high.
However, history has been known to repeat itself. So, while we might not need to fasten our seatbelts just yet, this historically high ratio is certainly worth paying attention to.
Ranked: The World’s 50 Top Countries by GDP, by Sector Breakdown
This graphic shows GDP by country, broken down into three main sectors: services, industry, and agriculture.
Visualized: The Three Pillars of GDP, by Country
Over the last several decades, the service sector has fueled the economic activity of the world’s largest countries. Driving this trend has been changes in consumption, the easing of trade barriers, and rapid advancements in tech.
We can see this in the gross domestic product (GDP) breakdown of each country, which gets divided into three broad sectors: services, industry, and agriculture.
The above graphic from Pranav Gavali shows GDP by country, and how each sector contributes to an economy’s output, with data from the World Bank.
Drivers of GDP, by Country
As the most important and fastest growing component of GDP, services make up almost 60% of GDP in the world’s 50 largest countries. Following this is the industrial sector which includes the production of raw goods.
Below, we show how each sector contributes to GDP by country as of 2021:
|🇰🇷 South Korea||57.0||32.4||1.8||8.8||$1.8|
|🇸🇦 Saudi Arabia||46.5||44.7||2.7||6.1||$0.8|
|🇭🇰 Hong Kong||89.7||6.0||0.1||4.3||$0.4|
|🇿🇦 South Africa||63.0||24.5||2.5||10.0||$0.4|
Industrial sector includes construction. Agriculture sector includes forestry and fishing. *Data as of 2019.
In the U.S., services make up nearly 78% of GDP. Apart from Hong Kong, it comprises the highest share of GDP across the world’s largest economies. Roughly 80% of American jobs in the private sector are in services, spanning from healthcare and entertainment to finance and logistics.
Like America, a growing share of China’s GDP is from services, contributing to almost 54% of total economic output, up from 44% in 2010. This can be attributed to rising incomes and higher productivity in the sector as the economy has grown and matured, among other factors.
In a departure from the top 10 biggest countries globally, agriculture continues to drive a large portion of India’s GDP. India is the world’s second largest producer of wheat and rice, with agriculture accounting for 44% of the country’s employment.
While the services sector has grown in India, it makes up a greater share in other emerging economies such as Brazil (58%), Mexico (59%), and the Philippines (61%).
Services-led growth has risen faster than manufacturing across many developing nations, underpinned by productivity growth.
This structural shift is seen across economies. In many countries in Africa, for instance, jobs have increasingly moved from agriculture to services and trade, where it now accounts for 42% of jobs.
These growth patterns are supported by rising incomes in developing economies, while innovation in tech is lowering barriers to enabling service growth. As the industrial sector makes up a lower share of trade and economic activity, the service sector is projected to make up 77% of global GDP by 2035.
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