The Warren Buffett indicator has just one job: to tell investors whether the stock market is overheating. And right now, at 228%, it’s sounding the alarm.
As a quick reminder, the indicator divides the total value of the US stock market by GDP. And as Buffett says, it’s “probably the best single measure of where valuations stand at any given moment.”
The problem today is that at its current level, the indicator is beyond the 200% threshold that the Oracle of Omaha warned is when investors are “playing with fire”.
Is disaster about to strike? Regardless, let me first say I’m not panicking. Here’s why.
Is a crash actually coming?
Stretched valuations are concerning, but alone don’t spell disaster. In fact, the indicator has been above its long-term trend for quite a few years now.
This is somewhat structural. Today’s US market is dominated by global technology companies that generate revenues well beyond the American economy.
Consequently, a simple market cap-versus-GDP comparison becomes somewhat less meaningful compared to the early 2000s. And as a result, anyone who’s been using it as gospel has so far potentially missed out on some terrific gains.
What should investors actually do today?
Even with the Buffett Indicator in the ‘danger zone’, the best strategy for investors remains the same. Stay focused on the long term and don’t try to time the market.
Too often, investors waiting for a crash or correction based on stretched indicators end up missing out on impressive returns that could decimate long-term wealth-building. Yet even with that in mind, this doesn’t mean the indicator should be ignored entirely.
There are some justifiable concerns about the current global economic landscape. As such, taking a more disciplined approach towards investing might be a prudent move. And that includes:
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Ensuring good portfolio diversification.
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Building a small cash buffer.
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Drip-feeding capital rather than making large lump-sum investments.
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And crucially, hunting for undervalued buying opportunities in an overpriced market.
Regarding the latter point, that’s where looking outside the US becomes especially interesting.
A bargain hiding in Britain?
While US stocks look expensive, the UK market continues to trade at a significant discount to global peers. One name that stands out today is Berkeley Group (LSE:BKG) – a premium housebuilder with shares recently down to their lowest level in nine years.
Despite what the weakened stock price suggests, institutional analysts seem to be growing bullish with a 16% 12-month share price rise being forecast. And company insiders are taking advantage, with several directors recently snapping up more shares.
