Wishing You a Cautious New Year

Wishing You a Cautious New Year

Published On: February 3, 2025

Written by: Ben Atwater and Matt Malick

Although market timing is impossible, there is an important long-term indicator that gives us caution.

We are not the only ones. Despite the euphoria on Main Street and Wall Street over rising stock indices – and downright madness as it relates to a basket of mega cap tech stocks – some of the most experienced market practitioners are worried about excessive market valuations.

One of those is Warren Buffett and his team at Berkshire Hathaway in Omaha, NE. For the past eight quarters, Berkshire Hathaway has been a net seller of equities, raking in $166 billion selling long-held stock positions.

The scale of these sales is historically large, and furthermore, Buffett is no longer even buying his own stock. For the first time since 2018 Buffett has not bought back any of Berkshire’s stock.

What leads him to this stance? In our view, it is his favored indicator, market capitalization to GDP.

The Market Cap to GDP Ratio (the so-called Buffett Indicator) is a measure of the total value of all publicly traded stocks in the U.S. divided by U.S. Gross Domestic Product (GDP). In other words, the aggregate value of the U.S. stock market divided by the total annual output of the U.S. economy. In this essay, we will use a measure that excludes financial corporations to give you a less cyclical version of the indicator.

Like all indicators, this one certainly has its shortcomings. Critics argue that with the global nature of S&P 500 companies, this measure has become meaningless. We would argue that this is partially true. However, it is also fair to say that the indicator has been in a long-term uptrend. This chart goes back to 1947, so its uptrend accounts for globalization. Additionally, we have entered a time where globalization is retreating.

Regardless, it is the extreme readings that matter. And we are at another extreme.

This chart ends as of Q3 of this year, so by the end of 2024 we will exceed the previous high hit in Q4 2021. Other meaningful tops and extremes happened in this indicator in Q1 of 2000 and Q2 of 2007. All three of these extremes preceded tough markets.

Another worrisome sign for chart watchers is the double top that we are potentially seeing – Q4 2021 and Q4 2024. A double top is a bearish technical reversal pattern that forms after an asset reaches a high price two consecutive times with a moderate decline between the two highs.

To reiterate, this is one indicator, although there are a variety of others that suggest a cautious outlook. And market timing, even over a multiyear period, does not work because of the myriad factors involved in financial markets. But we believe that risk assets in the U.S. have reached extreme valuation levels. We think that the importance of diversification will reemerge over the coming years. And we will be ever more vigilant as stewards of your investments. Although there is temptation to think short-term during manias, it is vital to remember that your finances are the most long-term of endeavors.

 

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