Warren Buffett’s indicator is flashing red. Are we in for a share market crash?

Global share markets have surged since the March 2020 post-crash lows.

Warren Buffett

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Warren Buffett may well be the best-known investor on the globe.

And for good reason.

He bought his first shares 80 years ago and clearly had a knack for understanding the markets.

The 91-year-old investor has now accumulated a net wealth of US$$101.3 billion (AU$136.9 billion), according to Forbes. That makes the Oracle of Omaha the sixth wealthiest man on Earth.

For the past many years, Warren Buffett has been at the helm of Berkshire Hathaway. And while he doesn’t get every market move right, when he speaks, investors tend to listen.

Which is why more than a few investors are taking note that the so-called “Buffett Indicator” is pointing towards a potential share market crash.

What is Warren Buffett saying on global share market valuations?

Warren Buffett’s “Buffett indicator”, if you’re not familiar, divides the total market capitalisation of all the listed shares across the world by global GDP. Any figure above 100% (meaning global shares are valued at more than the world’s total annual output) indicates shares are relatively overvalued.

Now, as Business Insider reports, “Warren Buffett’s favourite market indicator has surged to a record high of 142%, signalling US and international stocks are heavily overpriced and could plummet in the months ahead.”

Back in 2001, Buffett told Fortune magazine the indicator is “probably the best single measure of where valuations stand at any given moment”. It went into the red during the dotcom bust.

Any reading below 80% would “likely be lucrative” for investors to buy shares.

The valuation in the United States share markets using Warren Buffett’s indicator are even more dire. Dividing the total market cap of all US listed shares by US GDP gives an indicator reading of 208%.

Welt market analyst Holger Zschaepitz responded by tweeting (quoted by Business Insider), “BOOM! Global stocks have gained another $US1.6 ($AU2) trillion in market capitalization this week. Equities now worth $US120.3 ($AU162) trillion, highest in history.”

Should we be worried about a crash?

Warren Buffett is doing the right thing by sounding a note of caution.

However, it’s worth bearing in mind that we are not living in ordinary times.

COVID-19 has seen global governments and central banks take extraordinary actions over the past 18 months. This has driven the cost of money to record lows, helping drive up global share prices, while global GDP has been hampered by pandemic related lockdowns and border closures.

Hence, in these extraordinary times, the Buffett indicator may need some retuning.

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The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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