The Buffet Indicator

[tournesol]

The most interesting thing I've read recently is an explanation of a key indicator proposed by Warren Buffett to identify inflexion points in the market.

I usually switch off when people start referring to WB and claiming to recycle his insights, but actually the contents of the following links makes intuitive sense and, if nothing else, looks like it fits the data.

Basically it compares the total market cap of the entire US market with the US GDP/GNP

It's a bit like doing a P/E calculation at the level of the entire country.

Worth reading I think.

Here's a couple of links:-

hTTps://www.ccn.com/buffett-indicator-s ... -over-yet/

hTTps://www.gurufocus.com/stock-market-valuations.php

[jaizan]

What that indicator doesn't capture is:

1 The effect of global businesses, such as Microsoft, Apple, Shell, BP, HSBC etc. So the P is in the US and UK earnings, but the E is global. In some cases, quoted companies conduct most of their business overseas.

2 Increasing private equity ownership

3 Overseas ownership of businesses. Cadburys, Boots etc.

I would think it needs a hell of a lot of adjustment to be useful in the modern era.

[tournesol]

Jaizan

You remind me of those famous aeronautical engineers who examined the flight behaviour of bees and concluded that from an aerodynamic perspective it was impossible for bees to fly. Bees however were ignorant of that conclusion so carried on flying.

It's an indicator - it gives you a heads up. Of course its not perfect. Of course it's not precise. But it provided an early warning of the 2000-1 crash and the 2009-9 crash and the latest crash. That's 3 out of 3.

I was badly burned by the first 2 of those. With the help of the indicator I bailed out in February just before the current crash and have escaped very severe losses as a result. That's enough for me to have some respect for the indicator on an empirical basis rather than dismissing it on theoretical grounds.

I used to work in a French insurance business. I remember once putting forward a pragmatic solution to an urgent business problem and getting the response - "That's all very well in practice, but what about in theory?"

If you want to refine the basic idea, then please be my guest. I look forward to reading about it here.

[SalvorHardin]

The Buffett indicator crops up from time to time on the American Motley Fool's Berkshire Hathaway board. We don't pay too much attention to it (Berkshire Hathaway is my 3rd biggest shareholding, so I have quite a bit of skin in the game).

The problem is that it's out of date because it ignores the overseas earnings of American companies. Which have been increasing this century in large part due to technology shares.

Back in 2013 the Buffett indicator was saying "sell everything" (link below). Investors would have missed out of six years of growth had they followed it.

http://www.fool.com/amp/investing/general/2013/11/21/warren-buffetts-favorite-market-indicator-shows-th.aspx

Even after this year's falls, I'm only back to where I was in January 2019.

[tournesol]

Hi Salvor

I think you are (inadvertently) misrepresenting what the indicator does - or at least tries to do. It doesn't say "sell everything". It says "Valuations are in excess of past historical comparators. Beware. Be vigilant. Be careful"

I think of it as being like a warning that snow conditions are right for an avalanche. It doesn't mean that an avalanche is inevitable. It just means that conditions are dangerous. If you are skiing in such circumstances and you see the approach of something that could act as a trigger - a supersonic plane - a herd of wildebeest - a fireworks display - the world's loudest yodeller - whatever, then you are well advised to get off the slope and into safety

My primary investment focus for the past 20 years has been oil companies. By the end of last year I had diversified so that only 20% was in oil. Earlier this year I was troubled by the underperformance of my oily holdings. I was thinking of selling and re-investing in other sectors. That's when I came across the Buffett Indicator which suggested that the US market was significantly over-valued by comparison with historic norms. That made me pause in my thinking. Then the Saudis and the Russians locked horns and the oil price started to slide and almost simultaneously CV19 got out of its original foothold. I decided that the combination of oil and CV19 might trigger the overhanging avalanche. I sold everything and went 100% into cash. That turns out to have been very fortuitous.

I understand your reservations/criticisms of the Buffett Indicator, I am myself a natural sceptic about all crystal balls - but henceforth I will pay attention to it. Doesn't mean I will take it as the voice of God, but I will monitor it and will factor it into my thinking. How/why would I not?

[tournesol]

PS

Seems to me that the idea that something like this is outdated is equivalent to saying "This time it's different"

Maybe

Maybe not.

I could imagine revisiting the basic idea and adjusting it to take into a/c the kind of objections made by you and others. Perhaps the easiest way to do that would be simply to apply an uplift to the historic maxima/minima of the ratio. Perhaps 1:1 is no longer the equilibrium point, perhaps it should be 1.2. That would not stop you using the thought process embodied by the original idea.

Regards

T