Friday , 25 April 2014

Warren Buffett’s Favorite Valuation Metric Suggests Stock Market Is OVERvalued by 15%

Here’s some perspective on the potential value of the U.S. equity market using Warren Buffett’s favorite valuation metric -investing4 total stock market capitalization relative to GDP.

So says Cullen Roche (pragcap.com) in edited excerpts from his original article* entitled Updating Warren Buffett’s Favorite Valuation Metric.

[The following is presented by Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com and www.munKNEE.com and the FREE Market Intelligence Report newsletter (sample here – register here). The excerpts may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]

Cullen goes on to say in further edited excerpts:

There’s some natural upside bias in an indicator like this because the stock market is not the economy and, in fact, the total market cap of the U.S. equity market has tended to grow quite a bit faster than Gross National Product. Nevertheless, if we use a linear trendline we can better gauge where we are and, based on this perspective, the U.S. stock market is starting to looking a little expensive.

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At a level of 1.1 (using estimated Q4 GNP) the U.S. stock market is now about 15% above trend which would put our “fair value” for the S&P at about 1520 at present (all else equal).

Buffett_Metric-400x253

Obviously, this is a rather imprecise way of viewing things, but it does provide a bit of perspective on where we might be in the market cycle. Multiple expansion and paying more for less earnings appears to be the most obvious driver of the market at present.

[As Katchum says in his article**, "according to the stock valuation chart below, the stock market is now crossing the 115% ratio of total market cap against GNP which means we are crossing the border from modestly overvalued into significantly overvalued territory.

market cap to GDP ratio

If global GDP weakens next year, a drop in the stock market will not be far off."]

[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]

*http://pragcap.com/updating-warren-buffetts-favorite-valuation-metric#v4bZDm2siAL7KCQw.99 (Copyright © 2013 All Rights Reserved)

**http://katchum.blogspot.ca/2013/12/stock-market-just-became-significantly.html

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