IS THE MARKET OVERVALUED? USING THE BUFFETT INDICATOR.

By 

Søren Nielsen.

2017.

By this measure, the S&P 500 is overvalued by 72 %.

Many times, the great investors look at indicators of what’s happening in the overall stock market. 

The Warren Buffett Indicator is one indicator, named that because most likely because no one else is looking at it. Buffett compares the GDP (gross domestic product, as calculated by the Bureau of Labor Statistics) with the total market value of stocks in the S&P 500, the major market index.

A variant of the Buffet Indicator is based on the Wilshire 5000.

You can call this indicator the market-cap-to-GDP ratio. As a ratio expressed as a fraction, the numerator is the market cap, and the denominator is the GDP.

You can derive both the GDP number and the market cap from the Federal Reserve’s economic data. The Fed refers to the market cap as “Market Value of Equities Outstanding.”

A good Tips.

"If the market cap figure is greater than the GDP, then you should be less aggressive in your stock investing approach. If the market cap is much higher, then reduce your exposure to the stock market. If the GDP number is greater than the market cap, then consider “shopping” for some good value stocks to add to your portfolio."

For example, if the market cap for the S&P 500 is $9 trillion and the GDP is $10 trillion, then the ratio is 90 percent (or $9 trillion divided by $10 trillion). In that case, the stock market isn’t considered overvalued, so the indicator won’t be a concern (at least not according to the Buffett Indicator).

A good Tips to remember.

"The indicator starts to be a concern when the numerator (the market cap) exceeds the denominator (the GDP number). If this persists for more than one quarter, then it indicates that the stock market has entered overvalued territory."

Even if the market is slightly overvalued, that isn’t a reason to panic. It’s just a reason to cut back on additional investments.

During the first half of 2015, this indicator surpassed 128 percent.

The last time the indicator was at that high of a level was during the Internet/tech bubble period of 1999 through 2000, when it reached 153 percent.

Remember, a high Buffett Indicator suggests it’s time to be cautious. Don’t rush into stocks at this level; hold off or reduce your potential investment.

INVESTING IN STOCKS WITH BASIC KNOWLEDGE OF ECONOMICS.

Stocks represent ownership in companies, and stock markets are the places where stocks are bought and sold. Those places may be made of bricks and mortar, like the New York Stock Exchange, or they may be computer networks, like the Nasdaq.

A good tips to remember.

"In years past, when someone bought stock in a company, he would receive a physical certificate that proved how many shares he owned. These days, if you buy stock in a company, you don’t get a pretty piece of paper to prove it; you generally get electronic confirmation of the trade."

Having a working knowledge of basic economics and knowing how to read a stock table is crucial to your success as a stock investor.

The stock market and the economy are joined at the hip. The good or bad things that happen to one have a direct effect on the other.

Understanding basic economics can help you filter financial news to separate relevant information from the irrelevant in order to make better investment decisions.

Here are a few important economic concepts to be aware of:

Supply and demand: Supply and demand can be simply stated as the relationship between what’s available (the supply) and what people want and are willing to pay for (the demand). This equation is the main engine of economic activity and is extremely important for your stock investing analysis and decision-making process.

Cause and effect: Considering cause and effect is an exercise in logical thinking. If you were to pick up a prominent news report and read, “Companies in the table industry are expecting plummeting sales,” would you rush out and invest in companies that sell chairs or manufacture tablecloths?

When you read business news, play it out in your mind. What good (or bad) can logically be expected given a certain event or situation?

Economic effects from government actions: Nothing has a greater effect — good or bad — on investing and economics than government, which controls the money supply, credit, and all public securities markets.

Government actions usually manifest themselves as taxes, laws, or regulations.

They also can take on a more ominous appearance, such as war or the threat of war.

A single government action can have a far-reaching effect that can have a direct or indirect economic impact on your stock investments.

Trading in the stock market can be challenging and lucrative. To be a successful trader, you need to know how to identify and invest in bear and bull markets, and you need to know how to use market analysis tools to help develop your own trading system.

And, with the embarrassment of riches available on the Internet, you need to know the websites that offer the most help.

HOW TO IDENTIFY THE BEGINNING OF A BULL MARKET

If you’re into trading stocks, bonds, and other funds, being able to identify the signs of a bull market can help you plan your trading strategy for maximum benefit.

Signs that the market is entering a phase of investor confidence are in the following list:

• Bull markets begin before the economy starts to recover.
• Interest rates are low.
• Industrial production statistics are inching higher.
• Technology and cyclical stocks are starting to rise.
• The weekly chart of the S&P 500 shows higher highs and higher lows; the MACD (moving average convergence divergence) line is above the trigger line and rising.
• The bullish percent index indicator shows a bull alert or a bull confirmation pattern.

HOW TO IDENTIFY THE BEGINNING OF A BEAR MARKET

As you trade stock on the market, you need to know when the market is taking a downward turn — becoming a bear market. The signs in the following list indicate a bear market is approaching, so adjust your trading strategy accordingly:

• Bear markets typically begin before the economy starts to decline.
• Interest rates are rising.
• Industrial production is starting to fall.
• Basic material stocks, energy stocks, and consumer staples are performing well.
• The weekly chart of the S&P 500 shows lower highs and lower lows; the MACD (moving average convergence divergence) line is below the trigger line and falling.
• The bullish percent index indicator shows a bear alert or a bear confirmation pattern.

HOW TO TRADE IN A BEAR MARKET

When the market is reflecting investor fear and uncertainty — is a bear market in other words — your trading strategy should focus on looking to sell or short fundamentally weak companies with the following characteristics:

• With poor earnings or no earnings
• In a weak sector
• In a declining economy
• While the stock is approaching a technical sell signal on its bar chart and performing worse than the average stock with low relative strength

HOW TO TRADE IN A BULL MARKET

In a bull market, when investor confidence is high, the sound approach to trading is to look to buy fundamentally strong companies with the following characteristics:

• With earnings that are growing faster than average
• In a strong sector
• In a growing economy
• While the stock is approaching a technical buy signal on its bar chart and performing better than the average stock with high relative strength