Warren Buffett’s favorite measure of the health of the stock market is sending some serious warning messages. In fact, this so-called “Warren Buffett indicator” is projecting that the US stock market has to fall by a whopping 45.1% in order for the stock market to be considered fairly valued. We are going to go into more detail on the specifics you need to know later on in this video, but first, a story.
The year was 1999. Warren Buffett was an attendee at the exclusive Sun Valley Conference in Idaho. This annual event is invite only and its attendee list consists of some of the biggest names in business and finance during that year. For background, 1999 was the peak of the infamous dot com bubble. The stock market had been soaring to sky high levels, seemingly shattering a new record every week. The Tech heavy NASDAQ index had rallied from 1,500 in January of 1995 to as high as 8,500 by the soon to be peak in February of 2000. This stock market bubble was driven by young internet companies with virtually no revenue or profits who had become the darlings of the stock market. Companies like Pets.com, Webvan, and Boo.com. These companies had little to show in the way of actual financial success. However, even more importantly to Wall Street at the time, these companies were internet based. In the minds of Wall Street, these businesses were destined to be massively profitable one day as the internet continued to grow in popularity.
This optimism came at a hefty price tag. During the dot com bubble, these internet companies saw their valuations soar to billions of dollars. Making their founders and early investors rich and famous. As a result, many of these newly minted billionaires were invited to the Sun Valley conference in 1999. Many of those invited to the conference were asked to give a presentation about a topic of their choosing. For days, Buffett listened to these newly minted wealthy founders give talks about how stock valuations didn’t matter, and that the stock market was going to continue to rise forever.
Finally, the time came for Buffett to speak his mind. The Keynote presentation at the end of the multi day conference was none other than Buffett himself sharing his thoughts on the stock market. Buffett got up on stage in front of a room full of new internet millionaires and billionaires proceeded to explain to them in his own folksy way why all of them were wrong. Buffett went on to explain how the stock market was incredibly overvalued. He argued that stocks were pricing in an excessively optimistic future. To make this point, he compared the total market capitalization of the stock market at the time, to the size of the economy.
Stock prices were so inflated that the value of the stock market was significantly larger than the size of the US economy. Buffett explained how this was unsustainable and the stock market would have to decline significantly at some point. As I’m sure you can imagine, the newly rich internet executives did not like what Buffett had to say. Both in public and behind his back, many of these people claimed that Buffett was out of touch and washed up. They said Buffett simply couldn’t grasp the fact that this time things were different. Oh the famous last words of investing: “This time is different”
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