Warren Buffett Indicator Predicts Stock Market Crash in 2017
Warren Buffett Prediction on Stock Market in 2017
What are the top stock market predictions for 2017? When it comes to predicting the stock market, few are as accurate as Warren Buffett, the second-wealthiest person in the world, worth over $74.0 billion.
In 2016, a year that saw the S&P 500 advance 10%, Warren Buffett added around $12.0 billion to his fortune. According to Bloomberg, Buffett’s wealth increased by 19% in 2016 to $74.1 billion. According to Forbes, Warren Buffett’s wealth increased by 20% to $74.2 billion. No matter how you look at it, Buffett was the biggest winner among America’s elite.
Buffett has always had a knack for making money. Worth an estimated $6,000 when he was just 15 (1945), Buffett managed to build his wealth to over $74.0 billion as of March 2017. This puts him just behind Microsoft Corporation’s (NASDAQ:MSFT) Bill Gates at $86.0 billion.
Over the last 52 years, since present management took over, Warren Buffett’s Berkshire Hathaway Inc.’s (NYSE:BRK.A) per-share book value has grown from $19.00 to $172,108, a rate of 19% compounded annually.
After such a stellar year, what is Warren Buffett’s stock market prediction for 2017? If actions speak louder than words, then the “Oracle of Omaha” does not have a lot of faith in the stock market right now. Buffett’s stock market forecast may not be calling for an all-out crash, but every indicator suggests he’s waiting for a major correction.
Be Greedy When Others Are Fearful…
One of Warren Buffett’s greatest investing mantras is to “be greedy when others are fearful and fearful when others are greedy.” Never has more sound advice been given, especially in 2017.
We’ve just passed the halfway mark of 2017, and despite gridlock in Washington, drama in the White House, and barely-there economic growth, the S&P 500 remains bullish. The S&P 500 has advanced 9.8% and is in record territory. The S&P 500 is also up more than 14% since Trump won the U.S. election in November 2016.
Again, despite concerns about Trump’s proposed tax cuts and infrastructure spending, failure to pass his healthcare plan, desire to rewrite the North American Free Trade Agreement (NAFTA), possible trade wars with China, and weak economic indicators, Wall Street remains optimistic.
And that’s just what’s going on inside the U.S.
Across the pond, the U.K. is dealing with the consequences of its decision to leave the EU. Will Brexit be drawn out and painful? Will it undermine the U.K.’s economic growth and trip up the fragile European economy?
Lest we forget the sabre-rattling from North Korea, geopolitical tensions in the Middle East, and terrorist attacks. All of these events will have an impact on the U.S. economy and, by extension, the stock market.
So, does Warren Buffett see investors these days as being fearful or greedy? Or is the Oracle of Omaha taking a rare step down and waiting on the sidelines to see what happens?
Warren Buffett Indicator Shows That Stocks Are Significantly Overvalued
How does Warren Buffett continually manage to pick stock market winners? His investing strategy is simple. Invest in undervalued shareholder-friendly companies, with strong competitive advantages.
Or, put another way, Buffett buys good stocks at the right time. Moreover, while Berkshire Hathaway doesn’t provide dividends, Berkshire receives billions of dollars in dividend payouts each year that are dutifully reinvested. And lastly, Buffett’s favorite holding position is forever.
Right now, though, it seems as if Warren Buffett is going to have a hard time finding undervalued stocks to invest in. In fact, according to Buffett’s favorite valuation metric, stocks are significantly overvalued.
The market-cap-to-GDP ratio is affectionately referred to as the “Warren Buffett Indicator.” Back in 2001, Buffett told Fortune magazine that “it is probably the best single measure of where valuations stand at any given moment.” (Source: “Warren Buffett On The Stock Market,” Fortune, December 10, 2001.)
As the name suggests, the Warren Buffett Indicator compares the total price of all publicly traded companies to gross domestic product (GDP). It is a great tool to correlate stocks to valuations. After all, stocks are a reflection of the broader economy, and there should be some sort of link between economic output and earnings. On top of that, this should also be reflected in stocks and their valuations, and help investors decide whether they should buy, sell, or wait.
By all accounts, Warren Buffett is waiting.
A reading of 100% suggests that U.S. stocks are fairly valued. The higher the Warren Buffett Indicator is over 100%, the more overvalued the stock market. The market-cap-to-GDP ratio is currently at 128.9%.
The Warren Buffett Indicator has only been higher twice since 1950. In 1999, at the height of the dotcom bubble, the ratio was at 153.6%. In late 2015, it was at 129.7%. It was only at 108% before the 2008 financial crisis.
2 Other Indicators Show That Stocks Are Significantly Overvalued
Another key valuation metric also suggests that stocks are significantly overvalued. According to the Case Shiller cyclically adjusted price-to-earnings (CAPE) ratio, the S&P 500 is overvalued by 87.5%! The 10-year average is around 16. It is at 30.05 at the time of this writing.
That means for every $1.00 of earnings a company makes, investors are willing to pay $30.05. The ratio has only been higher once, in 2000, at the height of the dotcom bubble. It was at 30.00 in 1929, right before Black Tuesday. In each case, it was followed by a stock market crash. (Source: “Online Data Robert Shiller,” Yale University, last accessed July 25, 2017.)
According to Nobel Prize-winning economist Robert Shiller, the euphoria after Trump won the election has sent the markets into a frenzy of greed and irrationality that could send stocks plunging in a rerun of the 1929 stock market crash.
Warren Buffett and investors may have to wait a bit for that kind of crash to materialize. The early days of Trump have created a boom. But that too will end, when the Case Shiller P/E ratio gets closer to 45, where it was before the dotcom bust. (Source: “Trump will carry Wall Street to the giddy heights of the 1920s before a fantastic crash, economists warn,” The Telegraph, January 18, 2017.)
Finally, the Wilshire-5000-to-GDP is a market-cap weighted index of all stocks actively traded—U.S.-headquartered stocks that trade on the major exchanges—although the index is made up of around 3,700 components, not 5000. The Wiltshire is less well known than the other two but it is actually the largest index by market value in the world. The ratio is at an all-time high of around 149.3. (Source: “Wilshire 5000 Total Market Full Cap Index/Gross Domestic Product,” Federal Reserve Bank of St. Louis, last accessed July 25, 2017.)
Stocks are overvalued. It’s as simple as that. Eventually, though, stocks and their valuations will come more into line. For that to happen, stocks will need to crash. Thanks to weak global economic indicators, this reality may not be far off. If Trump’s economic road map fails to create any meaningful change in the coming months, you can expect impatient investors to react.
Warren Buffett Sitting on Record Stash of Cash
Another reason why we know that the outlook for stocks in 2017 and 2018 is entirely up in the air is that Warren Buffett is sitting on a record stockpile of cash. Rich people don’t sit on cash when interest rates are near zero if there are undervalued companies to buy.
At the end of the fourth quarter of 2016, Buffet’s Berkshire Hathaway was sitting on a record $86.0 billion in cash. That’s up from the end of the third quarter when he had a record $85.0 billion in cash and the second quarter of 2016 when he had a then-record $72.7 billion in cash on the books.
At the end of each of the last few quarters, the S&P 500 has been in record territory. So too have Buffett’s cash holdings. At the end of the second quarter of 2016, the S&P 500 was in record territory, near 2,098. The S&P 500 has been notching up record quarterly closes since then; the S&P 500 closed the third quarter of 2016 at 2,168; fourth quarter at 2,238; first quarter of 2017 at 2,368; and second quarter at 2,423. By all accounts, the S&P 500 will close at another record at the end of the third quarter.
Not so coincidently, Buffett has been sitting on record levels of cash at the end of the past number of quarters too. Chances are really good that Buffett will be sitting on a new record stash of cash when he makes his third-quarter regulatory filing.
In light of an overvalued stock market, what can Buffett do with that money? Investors have been calling for Berkshire Hathaway to pay a dividend for years. But Buffett has resisted, saying his astute acquisitions and stock picks will benefit shareholders more over the long run.
If the money is burning a hole in Buffett’s pocket, he could always do what other cash-rich companies do: buy back their stock.
Buffett is authorized to purchase shares of Berkshire Hathaway for less than 120% of book value. But that figure could be adjusted. Berkshire Hathaway’s book value of $178,025.25 puts it within 144% of book value.
If the markets are overvalued though, there’s only one spot Buffett is going to put his money, and that’s probably in his own company. At 144% of book value, many analysts still see Berkshire Hathaway as cheap, with a lot of upside when it comes to earnings.
Warren Buffett’s Actions Point to Stock Market Crash
Again, actions speak louder than words, and Buffett does not seem all that sure about the near-term direction of the stock market. His favorite valuation ratio says stocks are overvalued by nearly 29%. You can’t buy low when the markets are too high. Second, he’s sitting on a record pile of cash, and the most attractive undervalued stock right now is probably his own.
Will the stock market crash in 2017? As it currently stands, everything is in place for stocks to experience a serious correction. “When?” is the big question. It’s impossible to answer, but with the markets in record territory and momentum strong, the next stock market crash is not exactly right around the corner. But with valuations getting further and further out of whack, it just means stocks will have further to fall when stocks do crash again.
That doesn’t mean investors are in the clear in 2017. While a stock market crash induced by bad U.S. economic indicators is not all that likely in the coming months, there are a number of black swan events that could send stocks into a tailspin in 2017.
This is where the Oracle of Omaha shines, when investors are fearful and running for the exits. And with $85.0 billion in his pocket, Warren Buffett could make some stellar acquisitions and stock purchases when the markets have crashed.