According to Business Insider, in the near future, the stock market may sharply sink as Warren Buffett's indicator has climbed to 205%, signaling stocks are significantly overpriced and a crash may take place.
The Buffett indicator takes the combined market cap of all publicly traded US stocks and divides it by the latest quarterly figure for gross domestic product. It serves as a rough gauge of the stock market's valuation relative to the size of the economy. This mathematical equation has long been deemed a Buffett Indicator that reflects how the stock market develops relative to the world economy. Recently, the indicator has hit 205%, signaling that stock markets across the globe are overvalued compared to the global economy. Buffet says that the gauge spiking may be a "very strong warning signal of a future market crash".
In the second quarter of 2021, the US GDP amounted to $22.72 trillion, which was in line with the Buffett indicator (205%). This is much higher than the previous level of 187% recorded in the second quarter of 2020.
Importantly, Buffett praised his namesake gauge, calling it "probably the best single measure of where valuations stand at any given moment."
According to analysts, the Buffett indicator repeatedly and with high accuracy predicted the impending collapse of the stock market. During the dot-com bubble in the United States, it soared to a record high. Before the global financial crisis, this indicator behaved in a similar way. However, in both cases, it did not exceed 150%.
The pandemic slightly knocked down the accuracy of the Buffett indicator. The coronavirus outbreak had disrupted economic activity and dwindled GDP. As a result, the government had to resort to emergency measures, e.g. adopting huge stimulus packages and increasing asset purchases to pump up liquidity. This significantly affected the dynamic of the stock market. Hence, the Buffett indicator may be artificially inflated. So, when the economy starts recovering, the indicator may begin to decline.
However, a possible collapse of the stock market was predicted by other investors as well. Michael Burry, the investor of "The Big Short" fame, warned that the stock market is "dancing on a knife's edge" and the "mother of all crashes" is coming. Jeremy Grantham also predicted a "fully-fledged epic bubble" that he expects to burst spectacularly.
