‘Buffett Indicator’ Warns Stocks Doomed for Worse Crash Than 2008 | Hacker News Reader

‘Buffett Indicator’ Warns Stocks Doomed for Worse Crash Than 2008

ccn.com

60 pointsmgh262 comments

The indicator is stock market capitalization / GDP. Today's level exceeds the record set in 2000 (~150%).

You can get the graph shown in raster form in the article from the Federal Reserve:

https://fred.stlouisfed.org/series/DDDM01USA156NWDB

A point to consider: the Buffet Indicator peaks before a recession actually is recorded, then falls heading into the recession. At least going back to 1996.

Oddly, it looks like the Fed series lacks the last two years.

This article shows a series from present back to 1950:

https://www.advisorperspectives.com/dshort/updates/2020/01/0...

Here, it's interesting to note that the lowest level is ~30% (1954, 1983).

Discrepancies appear related to the numerator (Wilshire 5000 vs some other custom index).

It appears that the Fed data use inflation-adjusted GDP.

It's also interesting to look at the series from 1950 and see that regardless of "corrections" that there is a gradual upward trend, so even if a high value is predictive of a bubble we don't necessarily know what the threshold is.

I look at these headlines a few ways:

1. People have been saying next year is going to be total doom and gloom just about every year since around 2011 or so.

2. They’ve all basically been wrong up until now and if you got scared and sold out when the headlines started you would have lost a ton of $$$

3. Eventually the market will go down and someone will claim to be right, probably through sheer dumb luck

4. When the next cycle starts the media will be all over the person from #3 saying they are now again predicting something will happen, but they’ll likely be wrong this time

When you’ve lived though a few of the above cycles you learn to do your best to stay calm and take a balanced approach to life and money. Things go up and down in the short term but in the long term things have reliably gone up.

> in the long term things have reliably gone up

Growth can't last forever in a finite world, so things will start to decline eventually. The question is when...

It's a bit simplistic to argue that because things have gone up until now, they'll keep going up.

The world now is in a very different shape than it was 50 years ago. There are many global indicators that give us better insight than simply stating "tomorrow will be the same as today". Things like global warming, resource depletion...

Who says the world is effectively finite? We've consistently invented more to want and buy, which has promoted even activity, and so on, for the last millennium at least.

s/even/even more/

And yet if you actually try to invest for your life on this basis you will reach the end of your working life with very few assets to fall back on.

> Things go up and down in the short term but in the long term things have reliably gone up.

And yet, recent articles have warned that millennials may need to save more than prior generations, because people are predicting weaker economic growth over the next ~50 years or so than the previous.

Anyone trying to make economic predictions about timescales that large is blowing hot air.

I read a 2002 book that basically said “You’ll need to adjust your expectations of future equities growth. It’ll be more like 3% annually, not 7%”.

I was concerned.

Since that book was published, equities have gone up on average 6.6%, which includes the 2008 crash.

And of course in 2002 very few people were predicting that China would achieve the scale that it has at the pace that it has. A lot of people were predicting the rise of China in the 1990s. Almost nobody was calling for their GDP to 10x so rapidly, going from $1.4t in 2002 to $14t 17 years later.

That resulted in an additional $45-$50 trillion in new wealth in just China alone. The knock-on value creation is probably equal to that globally. Most predictions didn't see that coming at that scale and how it could further lift global S&P 500 type companies (and the US stock market along with it).

This is true!

I think my main point was past predictions about long term economic growth have been wrong in the past, so I would weigh new ones very carefully.

and ironically ETFs or something seem the only "sane" way to do so

It looks to me like the indicator has been above 2008 levels since 2014 and has been above 100% every year but one since 1998. The article doesn't give any kind of indication of what "too top-heavy" means, so it looks like they've picked a metric that has been above a threshold for a period of time that contained two market crashes, then just declared that said metric forecasts a worse crash.

The Buffett indicator may be worth paying attention to, and Buffett has certainly thought more about this than me. But given the data in the post, there's as much support for the record highs of the DJI warning of an impending stock crash as there is for the Buffett indicator.

Anyone who takes the 'Buffet Indicator' at face value, is themselves a fool. Anyone who thinks that Buffet got rich buy dividing one number by a different number, and that he would give away his golden-cow for free? Come on now... I've got a bridge I'd like to sell you.

Sorry, the "selling the Brooklyn Bridge" expression reached its expiration date in December 2019.

Buffet indicator just says that stocks are priced high relative to economy. It indicates smaller ROI in the future if you buy now. This can be completely acceptable. Market crash is just one way smaller ROI can actualize. Lower than average stock market growth for several years corrects the valuations just as easily.

Most things that lead to crash those that are not measured accurately and develop under radar. Shadow margin is a suspect. It's hard to know how large problem it is and it connects stocks and real estate in a dangerous way.

That's a great chart and a simple metric (total stock value / US GDP). I like it.

I certainly can't predict a crash but I find it hard to argue anything other than we are closer to the top than the bottom of the current cycle. At some point there'll be a reversion to mean, which always overcorrects in the short term.

That could be tomorrow, a month from now, a year from now or 5 years from now. Who knows? This bull market has certainly gone on for years longer than anyone would've predicted.

And the thing is we're also in a period of wealth creation unlike anything seen since probably Standard Oil and the railroads of the 19th century. This isn't the dot-com era of pets.com and the like. Apple, Google and Facebook generate profits of a kind probably not seen in a century or more (in relative terms).

So yeah, we live in unusual times.

Actually I think it's a terrible chart. The stock market is a lot older than 1998, so why does it only begin there?

"The line was high, then it was less high!" What happened to "we're not investing in wiggling lines"?

Because the monetary regimes of, say, the late 20s, or the early 50s, or even into the late 70s and into the deregulatory periods of the 1980s are so vastly different than what exists now, that a comparison across vast timeframes would be completely specious.

Not sure that is explicitly what they were trying to accomplish, but that is what I got out of the graphic.

I don’t think this indicator is relevant anymore. Nowadays, it’s extremely easy for anyone around the world to invest in US stocks when in 2000/2008 that was nearly impossible in the majority of countries. I’m from eastern europe and invested in a few american companies a while ago. People underestimate the value of that.

It doesn't change the main point, which is that the value of the stock market is derived from the value of the actual companies. It doesn't matter where the money is coming from to buy those stocks.

How is that value determined though? It's just by what people think the stock is worth. If you have more money coming in to the market the listed companies' stocks will naturally be at a higher price point.

>How is that value determined though?

By the real profits of the companies in question according to standard accounting rules.

It's not "perceived value" or "demand" or anything else that can be affected by speculation or hype. It's literally the units of money produced by the company that issued the stock.

Buffet's rule of thumb says that ultimately the value matters. Investors and banks can play whatever games they like trading securities, building new financial instruments, speculation, etc, but ultimately the value of stocks is tied to the amount of money produced as profit, and eventually the market corrects.

So far he's been right.

Capital doesn't have to be invested in stocks, much less American ones.

Strong point IMHO. Also, the indicator has been close to the same level since 2014 (6 years). If this indicator were perfectly predictive, then we would have seen a recession shortly after 2014.

I think this is the Fed trying for a long time to keep interest rates down, because they are worried about it crashing the economy.

Everyone, ie the government and corporations, have gone into record debt, so they are much more dependent on low interest rates then before.

The recent daily pump of billions into the repo market is the latest play to do this.

This as well as the deficit, is adding a lot of money that has to be placed somewhere. That's why the stocks, gold and bonds have all become more bought at the same time.

Some of this money gets into the hands of banks, who use it as collateral, for lending out even more money.

The banks are the ones, becoming overleveraged, who will be the first to fall.

This is also what my guess is that this escalation in Iran is about. This could also have been why 9/11 occurred. The government wants something to blame for the coming crash. They don't want people to suddenly see the economy crash for no reason and then blame the government, so they start a war to distract and give them something else to blame instead.

I have this theory that's seems too simple (and prior-confirming for me) to be true. My theory is that this run-up is caused by inequality, and is likely to continue until more is done about inequality, either politically or by market forces. Maybe we'll have repeating cycles of ever-bigger bubbles and ever-bigger corrections until something changes.

The theory goes like this: under inequality, wealth is concentrated at the top. People at the top look to invest money, but spend a smaller portion of it compared to people lower down the distribution. This has two effects:

1. There is more and more money chasing after returns. This has a tendency to drive asset prices ever-higher. 2. Since the people who would spend the money (i.e., the less wealthy) don't have it, making returns becomes more difficult.

Warren's quotes in the article get at this, with the idea of earnings being decoupled from stock valuations, until suddenly they forcefully re-couple, so to speak.

Higher savings lead to higher investment lead to lower interest rates lead to higher asset prices, sure.

However, the rest of your theory falls apart. Corporate profits have simultaneously been increasing, GDP is increasing, the claim that business is harder isn't reflected in the data.

Also, low interest rates aren't enough to account for a significant portion of the asset price increase. We had low interest rates in 2008 coincide with decreasing asset values.

Which part did you read as claiming "business is harder"?

"Since the people who would spend the money (i.e., the less wealthy) don't have it, making returns becomes more difficult."

The claim is that there's less spending and this means returns, i.e. business profits are harder to get.

I guess I read it more as valuations get bloated which makes the returns more difficult but not that business profits themselves are "harder" to get in an effort per unit sense.

It's talking about consumer spending, which would affect business profits potentially but not business valuations directly.

It's not the first article I read on HN about an upcoming recession. This is for sure self-centered but the questions I end up asking myself are mainly how it'll affect my life and career.

Questions like if there was a recession tomorrow would I still be able to apply at a cushy well-paid faang job or if it is even smart to switch job now since the newer you are the more likely your are to be cut off if there is a need for downsizing.

I've never lived through a recession as a working individual hence why the prospect makes me nervous. I figure that, over the course of one's life, one goes through a few of them and that (mostly) everyone seems to make it out ok but if someone has some insights to share I'll be grateful.

I've seen all sorts get laid off during downsizing. Doesn't matter about age, tenure, usefulness, etc. Full departments just get cut.

Thing that helped me most is diversification and conservatism.

Diversification: 1) wife has job in different industry, 2) my skills are applicable to different industries and especially different locations, 3) side projects make some money.

Conservatism: I only splurge on my main hobby and go cheap on everything else. I can cut my expenses down fast (house -> apartment; apartment -> live with family; car -> public transit).

> It's not the first article I read on HN about an upcoming recession.

Articles about an upcoming recession have been increasing in popularity in HN steady out since around 2016, by my observation.

Interest rates were substantially higher prior to the 2000 and 20008 bear markets though.

If companies park their money abroad, is that money part of the GDP? If not, then the Buffett Indicator can grow even further without problems.

Assuming by "park" you mean just sit on it, then no. Money that isn't spent is not part of GDP.

GDP is the total of all private investment + goods + services + government costs, basically.

Dividing one number by another number is a meaningless game of numerology.

Also note that "investment" here is economic investment not financial investment. It does not mean people buying stocks or bonds. It means building factories, equipment, durable goods, infrastructure, anything that lasts for a long time and helps produce more consumption in the future (these are not counted in goods and services).

GDP is an aggregate measure. When you buy a financial investment, someone else is selling it. For the aggregate it ads up to zero.

"Government costs" here means goods and services and investment that the government pays for. It's not always explicitly separated in the equation. GDP simplifies to goods+services+investment if each variable includes both what is paid for by government and by private individuals.

In the immortal words of Jack Bogle, "Nobody knows nothing."

Ignore that at your own peril.

(For an explanation, read Bogleheads.org, and prosper.)

So... everybody knows something?

"the Buffett indicator reflects Warren Buffett’s characteristically simple thinking about stock values. It’s the total stock market capitalization of the United States relative to U.S. GDP."

If a company goes public or is taken private, or if a company issues debt to buy back stock, that changes stock market cap but not GDP. Furthermore, the market cap to GDP measure ignores how profitable companies are. I don't think the Buffett indicator is a good measure.

It's not a rigorous argument to begin with, but your understanding is missing the point. "Stock values", and the assumed market values of everything really, are the measuring sticks by which we measure leverage. You can use stocks as collateral for loans, you can trade them for money, etc... The "Buffet Indicator" is measuring the relative leverage of the economy -- how much of our money is "real" (i.e. reflective of control of the means of production, to borrow a phrase) vs. how much of it is based on an assumption of market prices (a "bet", to borrow another). And it's out of whack, which really isn't surprising given that we're at the (presumably) tail end of a decade+ expansion.

You're just saying that if everyone ignored the stock market and kept working and buying and transacting as if nothing in those numbers mattered, that everything would continue to run in a steady state. And it would. But that's not the way real economies work.

I think you misunderstood the above poster. Diving stock by US GDP at best needs to be defended with a real argument, not taken as the word of investment divinity. Maybe there is an argument there, but "The number was big and then it was not big!" is a weak one.

What is the GDP? It's goods/services/stocks/and government spending. So you are (sort of) trying to figure out the ratio of stocks to the other things. Maybe intuitively we feel that investment should not be too much higher than the actual payoffs (goods/services) we are producing right now. But what exactly, is too high? The number is bigger than before... so what?

You're demanding... a first principles model of stock market prediction (something that obviously doesn't exist) before you'll buy an ad hoc napkin result showing that we're probably due for a correction in the relatively near term (something basically everyone agrees on)? Seriously?

I mean, this logic spins around too: if you think the market won't dip, what's your reasoning? The fact that you aren't a billionaire tells me you probably don't know any better than anyone else. At least this metric has empirical data (there's a chart right there in the article!) to back it up, and it was "developed" by a seasoned practitioner who most of us would agree is better at this stuff than randos on HN. I mean... it passes the smell test if nothing else.

Your first argument is right. You must correct for the changes in private versus public ratio.

Your second argument is not that good. Company profits are fraction of the GDP. Profits increase only in expense of wages, taxes, or investments and usually only temporarily.

ps.

Nonfinancial corporate business: Profits before tax/Gross Domestic Product

https://fred.stlouisfed.org/graph/?g=pR5f

That's probably why you are reading ycombinator and not on your private island.

You assume that super successful people don't read Hacker News? That's an interesting thought, but doesn't hold up to scrutiny. What he said is likely true. Furthermore, I'm not sure why the stock market should necessarily be tied to U.S. GDP save for the outsized influence that U.S. has on the world economy as a whole. A company like Apple, for example, sells products all around the world. Their market cap is pretty detached from the U.S. GDP.

Perhaps it'd be a good idea to rebalance your 401k portfolios, if you're fortunate enough to have savings.

Am curious as to what you (and others) think are the better funds (or other areas) to move money to to better weather a recession?

You can’t predict a recession, and you’ll just lose money by trying to. The sane approach to retirement savings is to invest more heavily in higher growth/risk assets the further you are away from retirement.

If you don’t need the money for another 30 years, it doesn’t matter if you lose 30% in one year. If you were gaining 10% most years, but have a couple of big downturns during your working lifetime, you’ll still come out well ahead of the person getting 3% every year.

recessions are an inevitable component of a business cycle. I can't predict when it will happen, but I can prepare for it to arrive when it surely will.

Preparing your investment portfolio for a recession means moving your money into lower risk, lower return investments. Trying to prepare for that is trying to time the market, which you can’t do. For retirement specifically, as long as retirement is sufficiently far away for you, then you’ll make the most money by forgetting that recessions even exist, and maximising for long term returns. Go look at pretty much any high growth mutual fund, even if it had a 30% down year in 2008, it’s 20 year returns will almost certainly exceed the returns of any low risk asset.

there is a ton of literature on effective investing strategies (equities vs bonds, et cetera). I myself an not qualified to advise you of a particular place to park your money.

Rebalancing means holding onto the same funds, but making sure your allocations are correct.

You basically sell the winners and buy the losers to get back to your original allocation.

I’m rebalancing to include more municipal bonds and less stocks. You can check charts for ETFs going back to 2008 and see which ones are recession resistant.

FYI, CCN stands for CryptoCoinsNews.

I wonder if this could spur a nonsensical flight into crypto. Are we due for another rush?

Consider the website is Crypto Coin News, I'm sure they want you to do exactly that. It's not "nonsensical" if it's essentially targeted propaganda put out from someone who would do quite well for themselves if people left traditional stocks and tried their hand at trading hopes and dreams of lambos instead.

God I hope so, these bags are killing me.

When has crypto shown to be a more stable investment than stocks or bonds?

Reply on news.ycombinator.com