This Indicator Made Warren Buffett Famous — But It's Been Wrong About The Market For Years

With the S&P 500 trading above 6,200 points and U.S. equities cruising into the July 4 holiday at all-time highs, long-term valuation metrics are sounding alarms.

The so-called Buffett Indicator, a popular long-term valuation tool among traditional investors, has surged to its most extreme reading ever.

Yet, that doesn't mean it's time to panic and dump your stocks overnight.

What Is The Buffett Indicator?

Named after Berkshire Hathaway's Warren Buffett, the indicator measures the total value of the U.S. stock market relative to the country's gross domestic product.

It provides a broad snapshot of how inflated equities may be versus the actual size of the economy.

As a legendary investor, Buffett helped popularize the indicator by endorsing it as a key gauge of stock market valuations. In a 2001 interview, he called it "probably the best single measure of where valuations stand at any given moment."

As of July 3, the indicator shows a 207% ratio between the total U.S. stock market value and gross domestic product (GDP), according to the version tracking the Wilshire 5000 index, which covers nearly all publicly traded U.S. equities.

That means the market is worth more than double the size of the U.S. economy. A narrower version focused on the S&P 500 vs. GDP stands at 176%, also hitting new record highs.

In theory, valuations this rich should precede poor future returns, or even worse, sharp pullbacks.

It might sound worrisome, but here's why that's not the full story.

The Buffett Indicator Says Sell, But Timing The Market Top Is A Different Game

This indicator has been flashing overvaluation for years, and yet markets have continued to rise.

Since January 2017, the S&P 500 – as tracked by the Vanguard S&P 500 ETF (NYSE:VOO) – has gained nearly 170% – excluding dividends – despite the Buffett Indicator staying above 100% almost the entire time.

Only during brief dips in December 2018 and March 2020 did it temporarily retreat below that mark.

Investors who exited the market based solely on this signal missed a powerful bull run fueled by low interest rates, strong corporate earnings and massive fiscal support.

Most strikingly, since October 2023, the S&P 500's valuation relative to GDP has remained above 125%, yet the index has added an impressive 50% gain in less than two years.

So why does the Buffett Indicator seem to be losing influence? In today’s market environment, valuation metrics alone haven't been reliable sell signals.

Real interest rates remain historically low, keeping borrowing costs manageable and supporting risk assets. At the same time, persistent fiscal spending continues to inject demand and liquidity into the economy.

The dominance of large-cap tech companies has led to greater earnings concentration, which in turn fuels stock valuations.

That said, dismissing the Buffett signal entirely could be just as risky. While it hasn't been reliable for short-term market timing, extreme valuations have historically led to longer-term mean reversion, even if it doesn't happen immediately.

Chart: The Market Looks Expensive By Buffett's Standards – But That Hasn't Stopped The Rally Yet

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