Buffett Indicator Flashes Warning as S&P 500 Hits Record High

Warren Buffett's famous market valuation metric, known as the "Buffett Indicator," is signaling high risk as U.S. stocks reach new peaks. The indicator compares the total value of U.S. stocks to the nation's Gross Domestic Product (GDP). As of mid-day April 17, 2024, with the S&P 500 index at a record 7140, the Buffett Indicator was reported at 232%.

In a December 2001 article for Fortune magazine, Buffett stated that a ratio approaching 200% meant investors were "playing with fire."

Origins of the Indicator

The metric was first highlighted when it reached approximately 200% at the peak of the dot-com bubble in March 2000. Buffett's core thesis is that stock market valuations cannot sustainably outpace GDP growth over the long term and will revert to a historical mean.

He suggested that a ratio of 70-80% was favorable for buying stocks, while a ratio near 200% indicated significant risk. Following the 2000 peak, the S&P 500 declined by almost half, bringing the indicator back below that 80% threshold.

The Current Market Landscape

The recent record comes amid a notable rally. The S&P 500 has risen over 13% since a decline prompted by the start of a war involving Iran. Underpinning current valuations are elevated corporate profits, which are reported to be 12% of GDP, compared to a historical average of 7-8%.

Furthermore, the S&P 500's price-to-earnings ratio based on forecast first-quarter GAAP earnings exceeds 28, compared to a 100-year average of around 17. Some market participants argue that this sustained high level of profit growth justifies current valuations.

Historical Precedents

History provides two recent cautionary examples following extreme readings of the Buffett Indicator:

• After the indicator reached 200% in 2000, the S&P 500 subsequently declined by approximately half.
• In November 2021, the indicator reached just over 200% before the S&P 500 fell by 19%.

Article and Editorial Background

The original Fortune article was adapted from a speech Buffett gave in July 2001. Writer Carol Loomis persuaded Buffett to adapt his remarks for publication. Loomis, who edited Berkshire Hathaway's annual letters for many years, was praised by Buffett in May 2024 during his last annual address as CEO.

The article's warning echoes a view held by the late economist Milton Friedman, who stated that corporate earnings cannot rise beyond their historic share of GDP for long periods.