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The Buffett Index - #4 - An Educational Series - Trey Reik

The Buffett Index - #4 - An Educational Series - Trey Reik
By Sprott Global Resource Investments Ltd. 2 years ago 1402 Views

Trey Reik is a Senior Portfolio Manager and Precious Metals Strategist at Sprott Asset Management USA, a division of Sprott Inc., a Toronto-based alternative asset manager. He is also the author of The Sprott Precious Metals Watch, a monthly newsletter produced by Sprott Asset Management LP.



February 23, 2016

Wouldn’t it be nice to have an overall picture of the stock market?

Following the stock market’s worst start to a year in history, there have been plenty of whispers threatening a market cooling, and many are wondering if this is a temporary pause in the overall market’s upward trend, or if a larger correction is in the offing. Investors look to a thousand different indicators, indexes and market shifts, hoping to divine an answer. We will never be able to predict the timing of market cycles, but we can observe the current state of the market relative to recent history. And while it is tempting to dig into the minutia, often a 30,000-foot view can help to shed light on the subject.

Sprott Senior Portfolio Manager Trey Reik recently published a comprehensive report looking specifically at gold’s current status within the context of the broader market. While Trey explains numerous facets of the gold market, he also offers a broad view of the current equity market, sharing an oft used metric first mentioned by Warren Buffett.

Warren Buffet has said that determining whether the market is expensive or cheap doesn't have to be a complicated process. There is a simple ratio that helps illustrate the relative value of stock prices to economic growth.

According to Buffett, consider: “The market value of all publicly traded securities as a percentage of the country's business -- that is, as a percentage of GNP. The ratio has certain limitations in telling you what you need to know. Still, it is probably the best single measure of where valuations stand at any given moment.”

In essence, this Buffett Indicator divides the total market capitalization of the U.S. stock market by gross national product, or GNP. GNP is a broader metric than GDP (gross domestic product), in that it includes the goods and services produced by Americans and American companies at home and aboard. (GDP restricts its calculations to new products and services sold within the borders). In short, GDP illustrates the productivity of the locality; GNP illustrates the productivity of the entire citizenry.

There are many variations of the Buffett Indicator. Some prefer to use GDP as the denominator, some the Wilshire 5000 to show smaller companies, some prefer to show corporate liabilities. And while the indicator doesn’t offer perfect timing, it does help to paint a picture of where the market, as a whole, stands.

So here is a historical view of the Buffett Indicator, using GDP and the US market cap.


If the ratio stays below 1 the market is not overvalued, relative to production. If the percentage relationship rises or falls greater than two standard deviations, a trend reversal may be due.

Note that this is not a device to help pick particular stocks, but it does show where equities stand within the context of the US economy. And today, we may be nearing that top line.

The Buffett Indicator is only one small portion of the gold story. To read it Trey’s full analysis, click here.


The author is not affiliated with, endorsed or sponsored by Sprott Money Ltd. The views and opinions expressed in this material are those of the author or guest speaker, are subject to change and may not necessarily reflect the opinions of Sprott Money Ltd. Sprott Money does not guarantee the accuracy, completeness, timeliness and reliability of the information or any results from its use.

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