Mixed signals

Warren Buffett once called it “probably the best single measure of where valuations stand”. He is, of course, referring to the eponymous Buffett Indicator, a ratio the Oracle of Omaha unveiled in a 2001 article. It’s the figure you get dividing US stock market capitalisation by gross domestic product (GDP). It aims to shine a light on whether markets are inflated compared to the so-called real economy. 

And at more than 200% – higher than at the dot-com peak – the indicator is flashing red. Talk of bubbles, an impending correction, and a frothy stock market is rife across the finance pundit and analyst ecosystem. 

Having navigated the dot-com blow out, Buffett argued his ratio was a good proxy for market valuation. At the time the Wilshire 5000 index had ballooned to more than 1.4 times GDP. Does Buffet’s 25-year-old ratio still warrant inclusion on investor dashboards?

The Oracle of Omaha

The Buffett Indicator’s simplicity is part of its charm. Many valuation or forecasting tools are high on their own technical complexity, riddled with arcane mumbo jumbo. Greek letters (β, α, σ) dominate modern portfolio theory and options pricing. Monte Carlo simulations pump out thousands of hypothetical market paths to estimate probabilities. Robert Shiller’s CAPE ratio (cyclically adjusted P/E) involves a 10-year, inflation-adjusted smoothing of earnings. 

The Buffett Indicator requires no statistical modelling. No assumptions about volatility or growth rates. No advanced maths. Just a simple comparison of two numbers. That brutal elegance makes it a popular shorthand for journalists and investors alike. 

At the time of writing, Buffett’s ratio hovers around 217%. It may help explain why his appetite for US equities has cooled. His conglomerate, Berkshire Hathaway, has been a net seller of equities for 11 straight quarters as of August 2025. Instead, the firm has funneled cash into US Treasury bills and other near-term safe havens. The firm’s cash pile has swelled to around $350 billion, more than the GDP of Finland.

But Berkshire’s size means it can’t easily dish out the dollars without risking price distortion. In today’s higher for longer new normal, US T-bills pay almost 5% – a safer and perhaps saner choice than tech stocks trading at dizzying valuations. Anyway, Buffett likes to keep his options open, ready to deploy capital as others lose their cool. As he put it, “a climate of fear is your friend when investing”.

Objects in mirror are closer than they appear

The world has certainly changed since 2001. Back then we dialled into the internet and rented DVDs from Netflix. There was no iPhone, no Facebook. Friends was the biggest thing on TV. On trading floors, bankers wore boxy suits with chunky ties and BlackBerrys. In that distant era, a neat ratio of market cap to GDP felt modern.

But today around 40% of S&P 500 revenues come from outside the US. Giants like Apple (AAPL) and Microsoft (MSFT) enjoy a global reach with profits only partially tied to US output. GDP also struggles to capture the value of software and associated intangibles that sit atop today’s interconnected network economy.

And the US economy is uniquely tilted toward capital markets, with household wealth tied to equities, pension funds, and ETFs. This passive bias to invest lifts the numerator relative to GDP, regardless of whether stocks are ‘overvalued’.

One number to rule them all

Markets are chocka with gauges. You have the CAPE ratio by Nobel laureate Shiller. It smooths earnings over ten years to iron out cycles. In 2000, it spiked above 40 – major bubble territory. Today it hovers in the mid-30s. High, but not dot-com-insane high.

Then there’s Tobin’s q, a ratio comparing market value to the replacement cost of assets. A high q suggests markets are pricing companies above the cost of rebuilding them from scratch. Like the Buffett Indicator, it has flashed red for yonks. But then again, we don’t necessarily think about the value of Alphabet (GOOGL) or Meta (META) in terms of replacement costs like we would for an old industrial economy company.

The Yield Curve is more of an economic signal. When short-term rates rise above long-term ones, recessions have tended to follow. CAPE was right on the dot-com bubble but stayed elevated throughout the 2010s, as stocks doubled and doubled again. The Yield Curve anticipated recessions in 2001 and 2008, but inverted in 2022 while the US economy stubbornly refused to fall into recession territory.

Emerging markets often look cheap by Buffett’s measure, with tiny stock markets alongside a booming GDP. But in many countries capital markets remain underdeveloped. The indicator measures valuations and a country’s degree of financialisation, as well as the complexity of the products it churns out.

In developed markets, the ratio makes more sense. Research looked at 14 countries in the period since 1973 and found the Buffett Indicator explained roughly 83% of the variation in 10-year equity returns on average. But its predictions varied, from 42% in some places to 94% in others.

It’s written in the stars

Humans have a soft spot for shortcuts. Behavioural economist Daniel Kahneman called them heuristics, rules of thumb that make knotty reality digestible. Markets are complexity manifest: trillions of trades, billions of data points, millions of motivations. The indicators compress the chaos into narratives humans can work with.

Riccardo Sabbatucci critiqued this technical analysis, comparing it to “astrology”. He said the hunt for patterns that aren't predictive is not unlike consulting horoscopes. 

Just as astrology promises order in the stars, valuation ratios and market dials promise order out of market chaos. Constellations like the Buffett Indicator, Shiller’s CAPE, and Tobin’s q fold trillions of dollars of trades into a single figure investors can point to like a star sign.

Playing with fire

Valuations matter, but earnings momentum also keeps markets buoyant. Fed rates and Treasury yields shape the cost of capital while flows into ETFs, hedge fund exposures, and options activity offer clues about who’s long or short. And inflation, geopolitics, and fiscal spending are gradual forces no chart can fold in neatly. The current AI boom, for example, has pushed Nvidia (NVDA) and peers into trillion-dollar territory regardless of Buffett Indicator warnings.

Rather than leaning on a single indicator, investors should consult the dashboard’s full suite of blinking lights, flickering dials, and numerical values. Earnings growth, interest rates and liquidity, positioning and sentiment, the macro context. All a veritable stew that shapes market mood and direction.

The Buffett Indicator reflects how much weight we put on financial markets relative to the real economy, which the real world occupies. Because the Buffet Indicator seeks to divine market value, whether or not it is entirely accurate is almost irrelevant. It shows we’re drawn to clear gauges, particularly in messy systems. In any event, it’s unwise to rely on any single measure. But in that aforementioned 2001 interview, Buffet said a ratio approaching 200% is “playing with fire”.

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