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Dow Jones Staggers as ‘Buffett Indicator’ Screams More Pain Ahead

Last Updated September 23, 2020 1:50 PM
Ben Brown
Last Updated September 23, 2020 1:50 PM
  • The Dow Jones Industrial Average led the stock market lower for a second straight day.
  • At roughly 15% below all-time highs, the U.S. stock market is still wildly overvalued.
  • Warren Buffett’s favorite valuation indicator is still near dot-com bubble highs.

The U.S. stock market is still wildly overvalued, according to Warren Buffett’s favorite indicator. After a strong relief rally, which saw the Dow Jones Industrial Average (DJIA) bounce 30% off March’s bottom, some analysts warn we’re due another reversal.

The so-called Buffett indicator is often used to identify frothy market conditions. It remains near record highs and only 5 points below the dot-com bubble peak in 2001 , indicating that equity valuations are still over-valued.

Buffet Indicator stock market
The Buffett Indicator tracks total market cap vs. GDP and is often used to signal overbought conditions. Source: Global Macro Monitor

The chart plots the total stock market capitalization against GDP. Buffett famously said this chart is a vital part of his market analysis .

It is probably the best single measure of where valuations stand at any given moment.

Dow headlines another disastrous day on Wall Street

The Dow Jones is headed for its second straight ugly loss. As of 9:40 am ET, the DJIA had fallen 588.27 points or 2.49% to 23,062.17.

dow jones today, djia
The Dow Jones fell sharply for a second straight day. | Source: Yahoo Finance

The S&P 500 and Nasdaq were down 2.06% and 1.86%, respectively.

Meanwhile, the oil price turned struggled again  after the West Texas Intermediate (WTI) May futures contract tumbled below zero for the first time in history on April 20. June futures dove nearly 30% to fall below $15 per barrel.

Is the Dow Jones overvalued?

The U.S. stock market crashed into the fastest bear market in history last month. But a strong bounce off the bottom leaves equities just 15% off their all-time highs. Legendary investor Howard Marks is nervous about this bounce . Asked if he was surprised at the relief rally, he said yes.

Yeah, I personally think so. I mean we’re only down 15% from the all-time high. And it seems to me like the world is more than 15% screwed up. I do think the [stock market] is ahead of itself.

Marks pointed to similar ‘dead cat bounce’ rallies after the 2001 and 2008 crashes, which ultimately led to new lows. He reminded us that it took seven years to reclaim the all-time high after the dot-com bubble burst. And five and a half years to reclaim the high after the Great Financial Crisis.

Is it really appropriate, given all the bad news, we should get back to the high in only 3 months. That seems inappropriately positive.

Warren Buffett is sitting this one out

Buffett himself has been relatively quiet during the latest downturn. But you can always follow the money. Buffett unloaded $30 million in Bank of New York stock during the recent relief rally. He also sold $314 million in Delta stock  (about 18% of his stake) and $74 million in Southwest Airlines.

In other words, he’s most-probably using the relief rally to take risk off the table and increase his cash position. It’s a strong hint that Berkshire Hathaway sees new lows ahead. Buffett’s business partner Charlie Munger appeared to agree with this in a rare interview last week.

Well, I would say basically we’re like the captain of a ship when the worst typhoon that’s ever happened comes. We just want to get through the typhoon, and we’d rather come out of it with a whole lot of liquidity. We’re not playing, ‘Oh goody, goody, everything’s going to hell, let’s plunge 100% of the reserves [into buying businesses].’

Buffett and Berkshire Hathaway are waiting for the storm to pass before they put their historic cash pile to work.

Oil continues to lead the decline

In a historic turn of events, the price of U.S. crude oil turned negative last night. The West Texas Intermediate (WTI) May futures contract sunk below zero, briefly hitting -$40.32. In other words, oil producers were paying others to take their barrels away. A catastrophic demand shock, combined with a lack of storage, sent the black gold into a death spiral.

The hangover lingers today. The Brent crude contract for June is now spiraling down to $20. The broad fall across the oil market points to a complete lack of demand in the wake of the coronavirus pandemic. This is an ominous sign for the global economy and the stock market.

Elsewhere today, earnings season continues. Coca-Cola, Philip Morris, Netflix, and Snap are among the big names in the spotlight today.