Ep 431 | The Buffett Indicator and its Impact on Our Investment Decisions

Thank you for joining me today. It's Brian Gubernick, and welcome to the No Days Off podcast, where we believe that every single day brings a new opportunity to get better. Today I want to get better at money, and I want to do so by discussing a financial metric that most are unaware of, but it's a metric that was popularized by our good friend Warren Buffett. If you want to know investment, if you want to study wealth, he's probably the guy to turn to and pick up some books and learn from. But Warren has a financial metric that became known as the Buffett Indicator, so obviously named after him, that most are unaware of, are not studying. But is something I really want to encourage our audience here at No Days Off to better understand. Now, this Buffett indicator is used to gauge whether the stock market is potentially overvalued or it's undervalued relative to the economy. Before I dive into how it's calculated, let me make sure I'd say that I am not giving financial advice. I'm not saying whether you should buy or sell based on the conversation we're having today, but I want to look at some of the facts. I want to look at some of the data, and I actually think what we're going to find might, may justify or explain some of the moves Warren has made, or better yet, the moves he hasn't made as of late. So the Buffett Indicator again compares the stock top, the stock market, uh, its value, its total market capitalization and compares it against the economy. Here's how it works, the formula. The numerator of this formula is the total market cap of all publicly traded stocks. So what is total market cap? This is the combined value of all publicly traded companies, all publicly traded stocks in the United States. Okay, so every single stock Total value added together represents the total market cap. So in essence, if you take all outstanding shares of every company on the stock market and you multiply that by the share value for each respective stock, and then you sum all of that together, you have the total market cap of all publicly traded stocks. That's the numerator. Now the denominator is Gross Domestic Product, is GDP. Remember, GDP measures the total economic output of a country, so it basically gives you a good sense of the overall size of the economy. That is the denominator. Numerator is total market cap divided by GDP. So this ratio compares the size of the stock market to the size of the economy, and this gives us a pretty broad view as to whether the stock market is possibly overvalued relative to the economy and economic fundamentals, or undervalued. Okay, hopefully you're still with me here. So let's, let's look at this moment in time, the day that we are recording this episode here in November 2024. Currently, the total market cap, you know, the summation of all of the stock that's outstanding in the market today. That number, uh, is roughly 60 million, uh, about $60.25 trillion— I'm sorry, $60.25 trillion. Okay, now that's total market cap. The total GDP right now at this very moment is $29 trillion. So the numerator is just over $60 trillion The denominator GDP is $29 trillion. So, when you run that math out, what you find is that the Buffett indicator at this very moment, the value of the Buffett indicator is about 207%. In essence, the US stock market is valued at 2x the current economy. Now, what does this mean? Translate this. Here's some of the key thresholds, uh, based on historical data. When the percentage— remember, the percentage we came up with was 207% in today's current market. In the traditional analysis of this particular financial metric, the Buffett Indicator, when the percent is less than 70%, The market is considered undervalued. In order to get to 70%, remember, you got to have a total market cap of a certain number, but then the, the GDP, the denominator, is going to be higher. That's what's going to lead to 70%. That would be considered undervalued. 70% to 100% is a market that's fairly valued. Greater than 100% is a market that's overvalued. And anything that's greater than about 120 to 140% historically indicates a significant overvaluation, and usually something that precedes a market correction or even a crash. Now, this Buffett indicator has been called by many an economist to be the best single measure of where valuations stand at any given moment. It's obviously a pretty high-level metric, and it— there's definitely some limitations to it, but it is a great comparison of the current stock market to the current economy. Now remember, I said 70 to 100% is a fairly valued market, and under 70% is about a— is a market that's undervalued. But anything in excess of 100%, especially 140% plus is something that's significantly overvalued. Yes, you're hearing this correctly. The Buffett indicator right now at 207% screams that the public market, US stocks, are greatly overvalued in comparison to the economy. Let that sink in. Does that mean there's going to be a crash? Absolutely not. I don't think that it— as much as I think this indicator is leaned into, there's so many other variables, there's so many other things to account for, like globalization, right? Like the, the world's economies have become more interrelated and codependent. So there's lots of companies in the US that are generating revenue outside of their home countries, and so maybe we're inflating market cap relative to domestic GDP. There's not an interest rate impact factored into this, uh, there's not sector shifts, there's not GDP timing lag. But even still, 207%, no matter what adjustments you make, it's pretty out of whack. Now, Warren Buffett and Berkshire Hathaway, his company, currently are sitting on about $325 billion in cash. For years people have said, why is Warren sitting on so much cash? By the way, they were saying that when he had $80 billion or $90 billion or $100 billion. Now we're like 3.5x that number, which is just astronomical. Yes, he is making a good chunk of money on, uh, that cash just sitting in Treasury bonds at 4% or 5%. I mean, they're making $15 billion or, you know, $12 to $15 billion on that just sitting there on the sidelines. So that's, that's nothing to scoff at. But why hasn't Warren put that money or deployed that money at a deeper level back into the market? I don't know if anybody can answer that, but it is worth thinking about, around, or talking about. Is it possible that Warren's using this metric and this metric is telling him the stock market is incredibly overvalued? As a result, is he sitting on the sideline waiting for things to slow, to calm a bit? The reality is Warren is famous for saying so many things, but the thing that I am constantly thinking about that Warren said multiple times over is to be fearful when others are greedy and to be greedy when others are fearful. If you're to describe today's investment climate, specifically in the stock market environment, right now we are experiencing a fair amount of greed. Greed in that people are investing, they're jumping in, they're trying to ride the wave. And Warren would tell you that's the time to be fearful, be a bit more cautious, be a bit more calculated. In his case, that may translate to $325 billion in cash sitting on the sideline. But where has Warren made so much of his money? It's in deploying capital when others become fearful. Because when others become fearful and the market begins to correct, it also starts to, you know, return from a point of overvalue and maybe to a point of even value or even undervalue. So take it for what it's worth, study the Buffett Indicator. One of the hardest things to do as an investor is to sit still and recognize that not making any play or making any decision is making a play and not making a decision. Like, to not go all in, then not deploy your money, is making a decision. And that's not necessarily a bad decision, at least if you're looking at the Buffett Indicator. That's all I have for you today, the No Days Off Podcast. Thank you so much for listening. And remember, every single day brings a new opportunity to get better. So let's get after it.