As of Jan. 3, the U.S. stock market is significantly overvalued with a Wilshire 5000 index / gross domestic product ratio of 126.4%. Based on this valuation, the stock market's annual return is -0.3% including dividends. Despite this, Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial) CEO Warren Buffett (Trades, Portfolio) still rings in 2017 bullish on stocks based on his asset allocations.
Figure 1 summarizes Berkshire Hathaway’s asset allocations as of Jan. 3. Even though the conglomerate slightly reduced its allocation in equities, Berkshire Hathaway still has more than 50% of its liquid assets in company stocks, significantly higher than the asset allocations in bonds and cash. Additionally, Berkshire’s stock relative to equity ratio is 37%, which is significantly higher than those for cash and bonds. Figures 2.1 to 2.3 illustrate the historical trend of Berkshire’s ratios relative to shareholder equity.
Figure 1
Figure 2.1
Figure 2.2
Figure 2.3
Based on the above figures, Buffett is likely bullish on stocks and bearish on bonds. Buffett’s latest portfolio contains about 37% and 30% in consumer defensive and financial services companies, respectively. The sector weights for Buffett’s portfolio are summarized in Figure 3.
Figure 3
As of Sept. 30, Buffett’s top four holdings are The Kraft Heinz Co. (KHC, Financial), Wells Fargo & Co. (WFC, Financial), The Coca-Cola Co. (KO, Financial) and International Business Machines Corp. (IBM, Financial). A previous article discusses how consumer defensive companies like Coca-Cola and Kraft Heinz offer good defensive-investing potential.
Counterintuitively, Buffett also claims that the percentage of total market cap relative to the U.S. gross national product most accurately measures “where valuations stand at any given moment.” Table 1 lists the “zones of discrimination” for the “Buffett indicator,” which GuruFocus defines as the ratio of the Wilshire 5000 over GNP.
| Ratio of Wilshire 5000 over GNP | Stock market valuation |
| Below 50% | Significantly undervalued |
| Between 50% to 75% | Modestly undervalued |
| Between 75% to 90% | Fair valued |
| Between 90% to 115% | Modestly overvalued |
| Over 115% | Significantly overvalued |
Table 1
As illustrated in Figure 4, the TMC / GDP ratio steadily increased from a 10-year low of 57% in 2009 to a new 10-year high of 126.4% during the first week of 2017. This likely occurred as the Wilshire 5000 index increased at a faster rate than did gross domestic product, as Figure 5 illustrates. As the market valuations remain over 115% throughout 2016, investors are preparing for a possible economic recession in the short term.
Figure 4
Figure 5
See also
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Disclosure: The author has no position in the stocks mentioned in this article.
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