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FTSE shares: is the Warren Buffett market indicator flashing caution?

The FTSE 100 index finished April with a strong monthly gain on hopes of a post-coronavirus V-shaped recovery. Yet it slumped deep into the red on 1 May. London’s top benchmark dived 2.3% on Friday after having recorded around an 8% rally last month. As I write, I see that Monday may also be a down day.

And the falls may not yet be over if Warren Buffett’s favourite market indicator holds true in the rest of the year. But despite a potential decline in May, Mr Buffett himself has just told investors to be invested in the markets for the long run. And I agree.

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Are markets getting expensive?

Analysts worldwide constantly work out whether stocks are cheap or expensive. Given the recent run-up in the markets, many investors are wondering whether they should be concerned about how markets could behave in the coming months.

Here’s where the ‘Buffett Indicator’ may come in. According to Mr Buffett, the undisputed master of value investing, it may be the “best single measure of where valuations stand at any given moment“.

This share market predictor now signals that broader markets are somewhat expensive. At the end of April, it hit a record high, according to various reports. Put another way, the overall confidence of market participants may be out of step with the broader economy. 

Let me first highlight that the Buffet Indicator takes the total market capitalisation (market cap) of US stocks and divides it by the quarterly gross domestic product (GDP) of the US. Thus it measures US equities and not the FTSE 100. So the US market cap-to-GDP ratio currently indicates caution. 

But if Wall Street falls hard, then the FTSE 100 can also be affected.

Have you watched Buffett’s meeting online?

On 2 May, Buffett spoke at his firm Berkshire Hathaway‘s annual meeting that was available to watch for global investors online. There were two main takeaways for me. The first is that the ‘Oracle of Omaha” isn’t buying US stocks yet. He said that he didn’t yet find value in any major acquisitions amid the pandemic decline in shares.

His inaction could also potentially confirm the US market warning we’re getting from the Buffett Indicator.

Is he right about the markets at this point? Predicting what indices and shares globally or in the UK may do in the coming months is anyone’s guess. However, if we were to get further worrying health or economic news, then investors may indeed be tempted to sell the markets soon and ask questions later.

Yet history tells us that markets tend to recover from losses, only to make new highs. And timing the market in the short run is difficult, especially for the average investor.

During the meeting, Buffett also underlined his firm belief that investors who buy stocks for the long run now will be amply rewarded. His emphasis was on disciplined, long-term investing over decades. And that was my second takeaway for the day.

Foolish takeaway

Analysts use different measures to estimate whether broader markets are undervalued or overvalued. And the Buffett Indicator is only one of them.

There are several FTSE 100 companies I’d consider buying for the long run, especially if there is any further weakness in their share prices. They include AstraZeneca, BT GroupBritish American Tobacco, Diageo, LLoyds, Ocado, and Smith & Nephew.

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tezcang has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Berkshire Hathaway (B shares). The Motley Fool UK has recommended Diageo and Lloyds Banking Group and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short June 2020 $205 calls on Berkshire Hathaway (B shares). Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.