What’s The Buffett Indicator and Should I Care?

I relearned a valuable lesson yesterday. It came courtesy of an article from Ben Carlson.

What Does the Buffett Indicator Say About Stocks Right Now?

The lesson – Everything is contextual and as the context changes so does the meaning of your indicator. Life is about meaning not about numbers and ratios.

It’s a bit like the Zen idea that a finger pointing at the moon is not the moon.

The Buffett Indicator

For the past twenty years the Buffet Indicator has been on the mind of many investment people. It is the ratio of American  stock market valuation to American GDP. The idea is that they are connected and as Buffett pointed out in 2001, the dot com crash may have been predictable. May have been!

Here is a chart from the article.

It seems the market valuations today are a little frothy.

Does that mean the market needs to drop by half or so to become rational?

As my granddaughter might say, “Maaaybe.”

How does the context matter?

There is another chart in the article that is very dense and harder to read, but makes an interesting point. The first of these is that the market is not composed of the same types of economic activity as the economy.

In particular

  • The technology sector makes up 38% of the stock market value but only 6% of the economy.
  • Government, agriculture, and miscellaneous services makes up 29% of the economy and virtually 0% of the stock market.

Further pointed out and perhaps the significant factor is this one.

  • The large businesses in the stock market are international and much of their value does not derive from their activity in the United States.

If the government share of economic activity is growing and much of the stock market valuation is not related to the U.S. economy, The Market valuation to GDP ratio is an apples and oranges comparison.

That cannot be a good thing on which to base decisions.

What might be interesting?

It might be possible to create a world stock market valuation and compare to the world GDP. That would delete the international bias in the large tech companies, but wouldn’t tell us much about the U.S. stock markets.

It is possible to take the government share out of the data and compare to that. I think we would discover the government is growing quickly and what does that mean, really?

It is further possible to bring in all other assets like corporate bonds, cash, bank deposits. crypto-currency, and real estate. The idea being to get a ratio of all investment assets compared to GDP. That would allow you to neutralize the effect of changing the allocations. Just now there is a lot of money in the stock market because fixed income rates are so low. That could easily change if rates changed upwards. The total would not be different and the GDP would be unchanged too, but any portion relative to GDP could change a lot.

And then there is the private business component. Businesses that are not public issuers cannot be ignored. They are a significant piece of the economy. Especially true in developing countries.

And the demographics. Aging populations have more money invested in stock markets than younger ones.

I suspect it would take a while to develop 50 years of history and I don’t know if it would matter anyway.

The bits to take away

Single factor indicators are the finger pointing. They are not the moon, but they might give you a cue to go looking for more meaning.

This particular indicator has too many variables to provide easy meaning.

It might not matter if it has no meaning if many people think it does. The market is after all a fear and greed based mechanism.

Decide if you care. If you have cash a sharp drop might be to your advantage.


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I build strategy and fact-based estate and income plans. The plans identify alternate ways and alternate timing to achieve both spending and estate distribution goals. In the past I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning, have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, Banks – from CIBC to the Business Development Bank.

Be in touch at 705-927-4770 or by email to don@moneyfyi.com

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