Warren Buffett Indicator Signals A Market Crash

Warren Buffett is the most successful American investor of the 20th century, recently moving from fourth to third as the who’s who of billionaires, according to Forbes Magazine. Born in 1930, Buffett has been in sales since he was a child, when he resold packs of gum and soda that he purchased wholesale. He began investing as a teenager and graduated high school with $6,000 in his savings account. His studies and growing experience contributed to his success as a twenty-five year old millionaire.

Buffet has long been associated with strict ethical standards in his personal and professional lives. His philosophies and techniques are examined and taught as examples of appropriate and successful practices for business students the world over. His company, Berkshire Hathaway, started when two cotton mills merged in 1955, is currently ranked fourth on 2014’s Fortune 500 list, and first in stock trading at more than $200,000 a share. His investments have shown consistent growth from the beginning.

Buffett’s Indicator Makes a Prediction

It is said that there are two schools of thought on the most accurate formula for indicating the true value of stock and the performance of the market: everybody else’s and Warren Buffett’s.

Buffett’s indicator is also known as the total market cap to GDP ratio. While most everyone else divides the market cap of the entire stock market by the gross national product, Buffett divides it by the gross domestic product of the country. Though the end product does not show a very significant difference between the two, the returns on investments are particularly telling.

According to Buffett, “If the percentage relationship falls to the 70% – 80% area, buying stocks is likely to work very well for you. If the ratio approaches 200% – as it did in 1999-2000 – you are playing with fire.” His prediction is that the stock market will recess or crash because it is overvaluated. The formula puts it at 132% in May 2015.

Buffett’s Past Predictions

You can set aside Buffett’s reputation and validated investment record, and consider the accuracy of his past market predictions alone. He certainly seems to know when to invest in the market by buying and selling at the most opportune times.

  • 1974 – In the midst of the OPEC crises of the 1970s, Buffett advised investors to buy. Not only did those investors profit by at least 30%, but they also were able to bear tremendous fruits from the early 1980s to late 1990s.
  • 1999 – While other professionals supported strong market returns that would influence future investments indefinitely, Buffett disagreed. Taking into consideration corporate earnings, interest rates, overall economic growth, and other financial factors, Buffett concluded that stocks would return to a low similar to that of the early 1980s.
  • 2008 – Buffett moved his personal portfolio back into stocks, right at the time of the collapse. Currently, stocks have improved twice as much in the past six years.
  • 2015 – The market is overvaluated and the fragile bubble in which it sits could burst at any time.

So, should investors take Buffett’s advice and run with it? If you have no reason to have faith in your investment, then why make it? Investments should be based on more than a company’s stock market share activity. There is also a little truth to the fact that his prediction itself may influence the market, but everyone is not going to bail out all at once. There are still a significant number of investors who are convinced that Buffett’s conclusions are a worst-case scenario, but more and more professionals are siding with the “Oracle of Omaha.”

 

Sources:

www.forbes.com, www.investopia.com, Finkle, T. A. (2010). Warren E. Buffett and Berkshire Hathaway, Inc.(Instructor’s Note). Journal of the International Academy for Case Studies, 16(6), 107.