So far this year, the U.S. stock market, as measured by the S&P 500, has returned about 10% — an average year’s worth of gains in just over three months.
After any first-quarter run-up, two brands of market-watchers tend to appear in headlines: those who think stocks can continue to ascend and those who warn that a bubble may be about to pop.
The latest rumbling from the latter camp have pointed out that stocks look overvalued by the standards of none other than Warren Buffett. The so-called Buffett indicator compares the total market capitalization (share prices times outstanding shares) of all U.S. stocks with the quarterly output of the U.S. economy.
Things are in normal territory if the total value of the Wilshire 5000 index (which measures the total market) is about on par with the latest quarterly GDP estimate. If stocks are at about 70% of GDP, they’re said to be undervalued. Stocks trading at about double the size of the economy is considered a major red flag.
As of late, the ratio is at about 190% — the highest mark in two years. In calendar year 2022, the last time stocks traded in this territory, the S&P 500 dropped 18%.
So is it time to brace for impact? Not quite yet, says Liz Young, head of investment strategy at SoFi.
“If we’re comparing a bubble to the late 90s and early 2000s, no this is not a bubble,” she says. “We’re in extended valuations, but we’re not outrageous, we’re not off the charts.”
Here’s where pros say the market stands now, and what it means for your portfolio.
A ‘comforting’ situation for stocks
Stick around in markets long enough, and you’ll eventually see a bubble pop. This occurs when investors bid up the price of an asset to the point where valuations become untethered from historical norms and underlying fundamentals. When everyone realizes that they’ve gotten out over their skis, they begin to take profits, prices fall, panic sets in and the asset falls rapidly in value.
Buffett’s favorite indicator is a blinking light to…
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