Posted on 18 February 2014 with 2 comments from readers
Whenever the Sage of Omaha is pushed on how he judges whether the US stock market is trading too high or too low he refers to the ratio between the value of US stocks and GDP as a reliable guage of where the market stands.
Analyst Doug Short has a version of the ‘Warren Buffett Indicator’ which uses the value of the Wilshire 5,000, a very broad index. It shows that stocks are more expensive than they were before the 2008 crash and almost as expensive as they were before the dot-com crash in 2000.
Warren Buffett is not exactly shouting it from the roof tops but his favorite indicator is pointing to an imminent 50 per cent crash in US stocks. The main indexes are all far too high. You don’t need to be a genius like Warren Buffett to see it.
Just consider the 30 per cent advance in the S&P 500 Index last year and the gain of around one tenth of that in US GDP. The overlay of 1928-9 on the current chart of the Dow Jones is compelling:
Again we appear to be on the precipice of a huge drop in the stock market, with a massive downside. Yet that would only wipe out the gains of the past two years. Given that they appear abnormal in the context of lack lustre US economic growth would this really be so remarkable?
Besides we know from long experience of charts in financial markets that the price spike we saw last year is entirely consistent with a market top. The sharp New Year sell-off followed by a brief but unconvincing dead-cat bounce back to the old high is also a classic market topping formation after a long rally.
Where’s the change in economic circumstances since January to justify this turnaround? There is none. Indeed there has been a lot of bad weather that will worsen the data for Q1.
Data today showed manufacturing in New York, northern New Jersey and southern Connecticut slowed this month. The Federal Reserve Bank of New York’s general economic index fell to 4.48 in February from 12.5 in January. Economists in a Bloomberg News survey predicted the index would decline to 8.5.
And who’s the only major investor still sat on a huge pile of cash? Why good old Warren Buffett of course who will be on hand to buy bargains when this crash happens…