Buffett Indicator recap
Berkshire Hathaway Inc. (BRK.A, Financial)(BRK.B, Financial) CEO Warren Buffett (Trades, Portfolio) said that the ratio of total market cap to gross domestic product is "probably the best single measure of where valuations stand at any given moment." On Thursday, the Buffett Indicator stood at 181.9%, up 1.2% from the Dec. 2 reading of 180.7%.
Based on the current market level, the implied market return using the standard Buffett Indicator is -2.3% per year over the next eight years assuming a reversion to the 20-year mean market valuation level. According to the predicted and actual returns chart, the implied market return ranges from -6.8% per year, assuming a reversion to a pessimistic case of 70% of the 20-year mean valuation level, to 0.8% per year, assuming a reversion to an optimistic case of 130% of the 20-year mean valuation level.
We now introduce a second factor that can influence the total market cap
Our research of economic cycles shows the total assets of the Federal Reserve Bank can also influence the total market cap. As part of its monetary policy, the Fed generally purchases assets when it wishes to increase monetary supply and sells assets when it wishes to decrease monetary supply.
If the Fed wishes to employ an expansionary monetary policy, it pours money into the market and drifts down the interest rate. Individuals and corporations can then borrow money at a lower interest rate, increasing consumption and business expansion. Likewise, a lower interest rate can also drive up investments. Both results may lead to inflows in the stock markets, increasing total market cap.
The new, modified Buffett Indicator stands at 135.6%. While the ratio still shows a significantly overvalued stock market, the implied market return improves to -0.5% per year assuming a reversion to the 20-year mean market level.
The implied market return using the modified Buffett Indicator ranges from -4.7%, assuming a reversion to a pessimistic case of 70% of the 20-year mean market level, to 2.6%, assuming a reversion to an optimistic case of 130% of the 20-year mean market level.
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The GuruFocus search bar allows users to search for a specific stock like Apple Inc. (AAPL, Financial), a specific guru like Warren Buffett (Trades, Portfolio), a specific Premium feature like the All-in-One Screener and much more. Figure 1 illustrates a sample screen shot where searching for "Buffett" yields results like Buffett's guru pages, the Buffett-Munger Screener and the Buffett Indicator page.
Disclosure: Long Apple.
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