I have recently noted that I am concerned about the level of stock prices these days.
The main reason for this concern is that every predictive valuation measure (emphasis on predictive) I look at suggests that stocks are drastically overvalued.
As many smart analysts have pointed out, valuation is useless as a near-term market-timing tool: It tells you nothing about what stocks are going to do next. But some valuation measures are very useful in predicting what stocks are going to do over the long haul, say 7-10 years. And the valuation measures that have been predictive in the past suggest that stock returns from this level over the next 7-10 years are likely to be lousy.
Today, I would like to draw your attention to one more valuation indicator that tells the same story.
It is often described as “Warren Buffett’s favourite stock valuation indicator.”
I have no idea whether it is actually Warren Buffett’s favourite indicator, but he has indeed praised it in the past.
This indicator compares the value of all publicly traded stocks with the size of the economy (GDP).
When this ratio is over a certain level, as it is now, the stock market is deemed expensive.
An excellent market analyst named Doug Short recently made two versions of the “Warren Buffett Indicator.” They use different measures of “market value of all equities,” but they show essentially the same thing: Stocks are really expensive.
The second one, which uses the value of the Wilshire 5,000, a very broad index of stocks, suggests that stocks are more expensive than they were in 2007 (pre-crash) and almost as expensive as they were in 2000 (pre-crash).