‘Buffett Indicator Flashes Warning for Stocks

By a method Warren Buffett once said was his preferred measure for evaluating the market, stocks are looking expensive.

Back in 2001, the legendary investor said that the “single best measure of where valuations stand” was the ratio of the value of publicly-traded companies in the U.S. to the country’s gross national product.

As of the end of the first quarter, the market capitalization of the companies listed on the New York Stock Exchange and the Nasdaq is about 150%, or 1.5, of GNP. By that calculation, the metric some have called the “Buffett Indicator” is now at its highest level since the dot-com era and above its historic norm of 119% over the past two decades.

“If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well,” the Berkshire Hathaway Inc.BRKA +0.25% chairman wrote in a 2001 essay co-authored by his longtime friend, Fortune journalist Carol Loomis. “If the ratio approaches 200%–as it did in 1999 and a part of 2000–you are playing with fire.”

The Buffett Indicator, like many other measures of equity valuations, has risen since the bull market began six years ago. With valuations near multi-year highs, there’s a debate as to whether stocks can keep advancing. Some are citing Mr. Buffett’s 2001 article as a reason for caution.

But when asked about the metric by Ms. Loomis at Berkshire’s annual meeting in May of this year, Mr. Buffett said the level of interest rates going forward is what’s going to shape his view on the costliness of stocks. “If we continue with these interest rates, stocks will look very cheap,” he told attendees at the widely-attended gathering. In a follow-up interview with CNBC, Mr. Buffett said that if borrowing costs normalize, stocks would be on the high side on a valuation basis.

“Many have cited this [Buffett] indicator being ‘high’ for awhile now and we’ve continued to see impressive gains,” said Ryan Detrick, strategist at See It Market. “Still, buying blindly here and now probably isn’t very wise.”