Warren Buffett Indicator: Market Crash Is Coming Soon

After giving the warning signal for the global economy, the Warren Buffett indicator just put the US market in red as well, which might be an indicator of another crash to come.

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Warren Buffett loves solid fundamentals and profitable businesses. This love is reflected in his portfolio, many of his investment decisions, and one of his favourite market indicators – The Warren Buffett indicator. It’s a ratio between the total market capitalization of any given country and its gross domestic product. It’s a straightforward ratio, especially if you consider how complex the stock market is, which is why many people are skeptical of its validity.

Two significant events endorse this indicator’s effectiveness. One was before the dot-com crash when the stock market valuation out-paced the GDP by a substantial margin. The second instance was when the indicator pointed towards an overvalued market (by a small margin) before the 2008 crash. The indicators value has been on the rise for a few years now, and it’s one of the reasons why Buffett has repeatedly said that U.S. securities are overvalued.

Record high overvaluation

According to the second quarter estimations, the U.S. GDP currently stands at $19.4 trillion. In contrast, the Wilshire 5000 Total Market Index (The most comprehensive index for the entire U.S. stock market) is valued at $35.5 trillion, putting the Warren Buffett indicator at a record high of 183% for the U.S. market. Even if we discard the nuances and technicalities that this indicator fails to capture, it’s easy to see that the U.S. stock market is brutally overvalued.

The situation might not be as dire for Canada, however. If we consider the second-quarter GDP and current market capitalization of the S&P/TSX Composite Index, which covers approximately 95% of the Canadian equities market, the ratio comes out to 127%. It’s not as overvalued as the US market, but a crash across the border might shake the TSX as well.

What to buy when the market falls

A market crash is typically a good time to buy overpriced stocks that you might not consider buying otherwise. One such stock is Waste Connections (TSX:WCN)(NYSE:WCN). This U.S.-based solid waste connection, recycling, and disposal company was overpriced before the pandemic as well. It is a decent growth stock with steady upward progress and a Dividend Aristocrat with a 1o-year streak of increasing dividends.

The yield isn’t reason enough to buy this stock (0.74%), but its dividend growth rate is excellent. Between 2016 and now, the company raised dividends four times, and over 54%. It’s still not enough to justify the trailing price to earnings of 127 times and a price to books of four times. That credit falls to the growth pace of the stock. After losing over 25% in valuation during the crash, the stock recovered to its pre-pandemic highest price mid-July.

The $26 billion market-cap company caters to millions of customers here in Canada and the U.S., including industrial, commercial, and residential customers.

Foolish takeaway

Warren Buffett is no longer sitting on the sidelines. But he still hasn’t put all that liquidity that he and Berkshire Hathaway have been sitting on to good use. He might also be waiting for the second crash to declare open season on discounted stocks. You can emulate this and start identifying prospects for the next crash as well.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Adam Othman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and recommends the following options: long January 2021 $200 calls on Berkshire Hathaway (B shares), short January 2021 $200 puts on Berkshire Hathaway (B shares), and short September 2020 $200 calls on Berkshire Hathaway (B shares).

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