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James Li
James Li
Articles (1531) 

Warren Buffett's Modified Market Indicator Tops 140%

US market remains significantly overvalued to start March

The U.S. stock market started the new month significantly overvalued based on Berkshire Hathaway Inc. (NYSE:BRK.A)(NYSE:BRK.B) CEO Warren Buffett (Trades, Portfolio)'s favorite market indicator.

On Tuesday, the ratio of total market cap to the sum of gross domestic product and total assets of the Federal Reserve Bank stood at 142.3%, up approximately 3% from the Feb. 1 value of 139.8%.

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U.S. indexes start new month with a bang, led by top Berkshire holding Apple

On Monday, the Dow Jones Industrial Average closed at 31,535.51, up over 600 points from last Friday's close of 30,932.37, boosted by stocks like Boeing Co. (NYSE:BA) and Apple Inc. (NASDAQ:AAPL).

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Buffett mentioned in his 2020 annual shareholder letter that he and Charlie Munger (Trades, Portfolio) view Berkshire's holdings of marketable stocks as "a collection of businesses":

"We do not control the operations of those companies, but we do share proportionately in their long-term prosperity."

The "Oracle of Omaha" said that Berkshire started buying shares of Apple for its main account in 2016, expanding the position to over 1 billion shares on a split-adjusted basis by the third quarter of 2018. Despite selling approximately 6% of its stake during the fourth quarter of 2020, Berkshire now owns over 5.2% of Apple's total shares outstanding. Shares occupy 43.61% of the insurance conglomerate's nearly $270 billion equity portfolio.

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Stock market remains significantly overvalued

On Tuesday, the Wilshire 5000 Full Cap Price Index stood at $41.342 trillion, which is approximately 1.42 times the sum of the most-recent reported gross domestic product and total assets of the Federal Reserve Bank. Based on the current market valuation levels, the implied return of the U.S. stock market is approximately -1.1% 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 -5.2% in the pessimistic case, which assumes a reversion to 70% of the 20-year mean market valuation level, to 2.1% in the optimistic case, which assumes a reversion to 130% of the 20-year mean market valuation level.

Disclosure: The author is long Apple. GuruFocus started tracking this year a modified version of Buffett's favorite market indicator, which includes the total assets of the Federal Reserve Bank. The ratio of total market cap to gross domestic product, the "legacy" Buffett indicator, stands at approximately 190% as of this writing.

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