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THE Buffett Indicator – a measure of stock market valuation – signals potential danger as it exceeds levels seen during the dot-com bubble and the Great Financial Crisis.
What happened: This indicator, attributed to Berkshire Hathaway Inc. (NYSE:BRK) (NYSE:BRK) CEO Warren Buffettcompares the market capitalization of stocks to gross domestic product (GDP) to determine whether stocks are overvalued or undervalued.
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The total market index, followed by the Wilshire 5000, and U.S. GDP are used to calculate this ratio. The Wilshire 5000, a market-cap-weighted index, tracks all publicly traded U.S. companies, which includes more than 3,000 companies. The higher the ratio, the more the market is considered overvalued.
Long-term trend data revealed that the current ratio of the Wilshire 5000 to GDP stands at approximately 208%, surpassing levels seen before the dot-com bubble and the Great Financial Crisis.
As a reminder, at the height of the Internet stock market frenzy in 2000, the Buffett indicator reached 140%. In 2007, just before the subprime mortgage crisis disrupted global markets, the ratio was around 110%.
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In a Fortune article Starting in 2001, Buffett referred to this level as “playing with fire”, referring to the dot-com bubble.
“Nearly two years ago, the ratio reached an all-time high,” Buffett wrote.
“That should have been a very strong wake-up call.”
Why it's important: Berkshire sold its stocks and strengthen its cash reserves recently. This could be a sign of Buffett's wariness of an overpriced market, or it could pave the way for possible acquisitions. Buffett has previously said Berkshire would be receptive to such opportunities.
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Despite this warning, some analysts remain optimistic about the future of the stock market. Bank of America analysts predicted positive outlook for stocks in 2025with the S&P 500 index expected to reach 6,666 by the end of 2025, a 10% increase from current levels. This forecast is based on confidence in productivity gains, the resilience of corporate profits and strategic sector rotation.
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