According to CMV, the current market valuation website, the so-called Buffett Indicator suggests the US stock market is “strongly overvalued”. However, it doesn’t consider UK shares.
The Buffett Indicator compares the overall US stock market valuation to the country’s gross domestic product (GDP). A country’s GDP measures the total value of all the finished goods and services produced on an annual basis.
The indicator’s at an all-time high
Billionaire investor Warren Buffett once said comparing the overall market valuation of stocks to GDP is “the best single measure of where valuations stand at any given moment.” And ever since, the ratio has borne his name. But I expect that might irk him a bit. Because CMV reckons Buffett has since retreated from his comment. And he’s now less likely to label any single measure as consistent or comprehensive, over time.
Nevertheless, CMV’s figures have it that the aggregate US market valuation of stocks is near $56trn and the country’s GDP is close to $23trn. To get the Buffett Indicator, we need to divide $56trn by $23trn. And that shows the valuation of US stocks is around 243% that of GDP.
To put that in perspective, CMV reckons the current percentage is around 95% higher than the long-term historical trendline. In other words, the aggregate capitalisation of US stocks is almost twice the valuation the trend line suggests to be fair.
The figure’s at an all-time high. And the only time it got near the current level is at the top of the internet bubble at the beginning of the century. Back then, the Buffett Indicator peaked at about 67% higher than the long-term historical trendline.
Why I’m still buying UK shares
Scary stuff! But I’m not about to sell all my UK shares and run for the hills. The first obvious reason for keeping the faith with shares is that aggregated measures don’t allow for differences. Not all stocks are over-valued. And over-valuation seems to be a particular problem in the US market, which is stuffed full of tech growth companies.
Here, we have many UK shares in cyclical and defensive sectors with more reasonable valuations. And foreign investors have been drawn to the good value they’ve been seeing in the London Stock Market for some time. If UK shares are attractive to them, they’re attractive to me.
Another important factor is the ultra-low interest rate environment, which works to drive up valuations. For example, property (real estate) and equities (shares) offer higher potential returns than bonds and cash savings accounts. Therefore, valuations in those attractive assets have been rising.
In that respect, the situation today is different from in 2000. When the internet bubble was near its peak, interest rates were higher and closer to historical norms. It seems to me interest rates will need to rise substantially to reverse support for stocks. And it’s hard for me to imagine that happening quickly in the UK.
After all, we’ve got the ongoing drags on the economy caused by the pandemic and Brexit. It seems unlikely ministers will crash economic growth anytime soon by hiking the base interest rate to historical levels.
For me, it’s business as usual seeking out good value UK shares to buy and hold. And that’s despite the extraordinarily high reading from the Buffett Indicator.
