2 Warren Buffett Indicators | Market Cap to GDP + Berkshire Cash Position

Follow the smart money… that’s easy to say but hard to do. You’ll find hot stock tips from friends, coworkers, and other market pundits. But instead, it’s usually best to avoid them. You can stick to the tried-and-true Warren Buffett methods. And there are two Warren Buffett indicators I check often.

The first is one of Warren Buffett’s favorites. It shows total stock market cap to GDP. It’s a good long-term indicator of market valuations. And the second indicator goes in tandem. It’s Berkshire Hathaway’s cash position.

I traveled to Berkshire Hathaway’s annual shareholders meeting about five years ago. It was legendary to see Buffett and Charlie Munger answer questions for hours on end. There’s a great deal we can learn from two of the world’s best investors. For example, they avoid investing in precious metals. Here’s why gold is a bad investment.

If you invested $100 with Buffett back in 1964, it’d now be worth $2.4 million. This massive return is why millions of investors follow his every move.

Stock Market Cap to GDP

Total U.S. stock market cap to GDP has climbed above 150%. And that’s not surprising after over a 10-year bull market… but it’s now above the previous two highs.

The Warren Buffett Indicator (total U.S. stock market cap to GDP) is up above 150% from the low in 2008. The stock market is overvalued relative to the economy.

The last two times the Warren Buffett indicator climbed close to this level, a stock market crash followed. This is a great high level view of the market’s valuation and it’s just one of many stock market crash indicators I follow.

Investors have pushed up stock prices but the underlying economy hasn’t grown at the same rate. This has made it hard for value investors.

Berkshire Hathaway’s Cash Piles Up

Warren Buffett is piling up cash while waiting for better buying opportunities. The chart below shows the changes in total annual cash and cash equivalents.

Berkshire Hathaway's cash is up 500% from it's low in 2008. Buffett's holding company has $122 billion in cash pile.

Since 2008, Berkshire Hathaway’s cash position has climbed about 500%. The company is now sitting on $122 billion. For comparison, that’s just over the size of Ecuador or Puerto Rico’s economy (as measured by GDP).

The 10-year bull market has made it hard for Buffett to find worthwhile investments. Yet, he’s willing to wait for better deals.

The investing legend knows that losing the battle for yield today can result in winning the long game. Over 53 years, Berkshire Hathaway has underperformed the S&P 500 only 17 times and some of the lower returns were back-to-back.

Missing a few years of returns is better than buying into overvalued stocks…

Stock Market Return Expectations

The Warren Buffett indicators above are some of many pointing to an overvalued market. For example, the popular PE ratio sits at about 22 and that’s well above its long-term average of 16.

When the PE ratio is 22, the S&P 500 has returned an average of 4.1% each year for the following ten years (CAGR). That’s a terrible risk adjusted return.

The chart below shows the correlation between the PE ratio and the subsequent 10 year returns. It includes over 50 years of data.

S&P 500 PE Ratio and 10-year Returns Correlation Chart

This is compelling evidence to avoid buying a basket of stocks for the long haul today. Wait for the PE ratio to revert to its mean or drop even further.

Investing is a game of probabilities. By crunching the numbers and pinpointing trends, you can improve your odds and magnitude of success.

Ideas are important but the data to back it up is crucial… the PE ratio is just one key indicator of long-term stock market returns.

Final Thoughts

If you want to improve your investment strategies and understanding of the world, it’s good to look at long-term historical trends. The PE ratio and Warren Buffett indicators are a good place to start. You can find four other indicators in my article: Stock Market Crash 2020.

Thanks for checking out my recent research. I work a full-time job and this blog is a passion project on the side. I enjoy sharing my ideas and I hope you find them useful.

I would really appreciate any feedback in the comments below or in a direct message… but you are free to accept or refuse this request.

Invest mindfully,

Brian Kehm

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