One chart that has been getting some attention recently is the so-called “Buffett Indicator.”

One chart that has been getting some attention recently is the so-called “Buffett Indicator,” which is the market capitalization of the US equity market divided by US GDP. It’s not surprising that a non-nonsense investor like Warren Buffett would like this indicator. Ultimately, corporate earnings come from economic activity, so if the market capitalization to GDP ratio is high, it suggests that stocks have become overvalued relative to the underlying drivers of profit. It’s a simple way to cut through a lot of noise to get one number that reflects the relative value of the US stock market. In a 2001 interview with Fortune magazine, Buffett called it “probably the best single measure of where valuations stand at any given moment.”

The reason the indicator has been getting attention recently is that it currently sits at its highest level ever, north of 200%, pointing to a severely overvalued market. So, should we dump all our equity exposure before the reckoning? Buffett is perhaps the most successful investor ever, so it would be unwise to dismiss his preferred indicator out of hand. However, there are some counterpoints to the notion that this is the most overvalued market in history. When Buffett spoke to Fortune 24 years ago, we were only in the early stages of globalization. Now, international markets account for a much larger share of revenue for US firms.

Combined, NVIDIA (NVDA), Apple (AAPL) and Microsoft (MSFT) account for more than 20% of the market cap of the S&P 500 (SPX). But MSFT is the only one of the three that derives more than half of its revenue from the US (just over 51% according to FactSet). Meanwhile, NVDA gets only about 47% of its revenue from the US and AAPL only about 36%. So, while the US economy is still a major factor in US firms’ earnings, it does not hold the same sway it did a generation ago. This may be why other valuation measures – like price-to-earnings – are above their long-term averages, but significantly less stretched than the market-cap-to-GDP ratio.

So, the “Buffett Indicator” may not be as powerful as it was 20 years ago, but is it right this time? That depends on your definition of “right” and your time horizon. Over the long-term, it will undoubtedly turn out to be “right” – which is to say that over the long-term we will see a double-digit decline in US equities. The market moves in cycles, when it bottoms and begins to recover, the countdown to the next downturn has already begun. This isn’t pessimism, it’s just a fact of life, as we’ve discussed previously.

But as trend followers, we’re concerned about what the market is doing now. The name of the game isn’t worrying whether a downturn is coming – a downturn is always coming. The goal is to identify the trend and follow it until it begins to break down. Of course, it is possible that we could see a downturn begin in the short term, but there are few tangible signs that the trend is changing. US equities remain at the top of the DALI asset class rankings and the US equity core percentile rank sits at 97%.

While there are few signs that the relative strength of US equities is waning, if stretched valuations have you worried that a downturn could start in short order there are a few things you can do now :

• Make sure you have a plan. Don’t try to cobble one together after things have already started going south. Which indicators will you use to know if the tide is starting to turn? Are you using models that can get defensive if needed?
• Don’t be complacent about weeding out individual stocks that are breaking down. You may get away with complacency when it comes to beta exposure – QQQ ultimately recovered from the dot com crash, but people who held on to shares of Pets.com wish they hadn’t.
• Consider some insurance. 5% out-of-the-money January 2026 SPY puts can currently be had for about 2% of the price of the underlying. If things do start to sour, hedging will quickly become more expensive.
• Don’t assume. We typically think of gold (GC/) as a haven asset that does well in downturns. But it’s up more than 40% over the last year and could be a target for profit taking if the market begins de-risking. The past can be a useful guide, but make sure you’re watching where relative strength is now.   

There is no doubt that Warren Buffett is one of the greatest investors in history, but we wonder if the "Buffett Indicator" has become less useful as a valuation metric in the face of globalization. While other metrics also suggest that valuations may be extended, they are not near the extreme level of the market-cap-to-GDP ratio. Meanwhile, there are few signs that the trend in US equities is shifting.