Get to know Buffet Indicator, warning U.S. stocks to risk bubble crisis

Have you ever heard about “Economy Bubble”? This word is like a nightmare for any investors who have ever heard it. Therefore, investors need to have a tool to view the overall stock market. The popular tool is the “Buffet Indicator.” Let ACU PAY tell you what the Buffet Indicator is!

Get to know the Buffet Indicator, bubble crisis warning tool

We can tell from the name of the indicator that it originated from Warren Buffet, an investor who is accepted worldwide. Back in 2001, Warren Buffett gave an interview saying that the way to view the stock market overview is whether cheap or expensive and whether prices are reasonable or not easily by comparing between

The market capitalization of all listed companies in the stock market.
Gross National Product (GDP) value of that country

It became the “Market cap to GDP ratio” formula that can be easily calculated by dividing the corporate value of every stock by GDP, the economic value. Later, this formula was named “Buffet Indicator” after the inventor.

Using the Buffett Indicator is not difficult. Warren Buffett says 100% is fair value. If the Buffett Indicator is close to 70%, the stock market may be in a cheap range, it is considered an undervalued price.

On the other hand, if the Buffet Indicator rises to the 200% level, it means that the stock market may be in an overvalued range, a warning sign that stocks that investors are playing are at risk of a bubble crisis.

Example of Buffet Indicator

Warren Buffett gave an example that in 1999, the U.S. Buffet Indicator once climbed nearly 200%. In other words, the stock market accounted for nearly twice the GDP. Only a year later, the Dot-Com Crisis hit. The peak year of the Buffett Indicator was in 2020 which reached over 200% before the S&P 500 index was poured over -20% in the following year.

Restrictions for Using Buffet Indicator

However, the Buffett Indicator is also limited. For example, suppose companies in the stock market have other nationalities listed but do not operate in that country. In that case, the Buffett Indicator cannot be used because it cannot be reflected in the GDP value.

In addition, Buffett’s Indicator comparison data in the past also need to be considered in different contexts in that period, including financial measures and policy interest rates.

The Buffett Indicator is a useful tool to help analyze the stock market situation against economic growth, whether the stock will be in a bubble or not.

Nevertheless, there are many limitations such as inflation, interest rates, corporate earnings, and political factors. We should analyze the instrument along with other aspects of analysis.