Warren Buffett's favorite market gage is approaching a record peak, suggesting that stocks are overvalued and will decline in the coming months.

Warren Buffett's favorite market gage is approaching a record peak, suggesting that stocks are overvalued and will decline in the coming months.

Warren Buffett's favorite market measure is nearing a record peak, suggesting markets are overvalued and will soon crash. The "Buffett indicator" distinguishes the aggregate market capitalization of publicly trading stocks by the country's quarterly gross domestic product. Investors use it as a basic indicator of the value of the capital market compared to the scale of the economy. The Wilshire 5000 Total Stock Index was worth around $36.1 trillion at the end of Thursday, although advance forecasts indicate that US GDP rose to $21.2 trillion in the third quarter. Using these figures, the Buffett indicator stands at about 170 per cent, similar to its all-time peak. "The stock market has never been as expensive as it is today, largely the product of soaring valuations amid deteriorating fundamentals," Jesse Felder, money manager and founder of The Felder Report, wrote in a recent blog post on Wednesday. "Not only does this mean that forward returns will likely be exceptionally poor, it means that downside risk has also never been greater than it is today," he added. The reading of the Buffett measure combined with extreme amounts of margin debt and market momentum "paint a picture of an extremely overvalued stock market, driven by a speculative euphoria even while the price trend is running out of steam," he said. "Investors ought to exercise a great deal of caution towards equities as an asset class," Felder continued. Sven Henrich, the founder of NorthmanTrader, a platform for market research, repeated Felder's remarks in a Thursday tweet saying that the reading of the Buffett indicator revealed "a record disconnect between asset prices vis a vis the economy."

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Buffett celebrated his homonymous gage in a Fortune Magazine essay almost 19 years ago as "probably the best single measure of where valuations stand at any given moment." The billionaire businessman and the CEO of Berkshire Hathaway said that the ratio of peaking to record high during the dot-com bubble "should have been a very strong warning signal" of an inevitable collapse. The Buffett indicator has its flaws. For eg, it relates current market capitalizations to the previous quarter's GDP, US-listed firms do not actually contribute to the US economy, and GDP does not account for international income. Yet the measure has a track record for forecasting downturns. It rose until the dot-com bubble exploded and rose in the months leading up to the 2008 financial crisis. This is the St. Louis Fed version of the Buffett measure (both market caps and GDP are indexed to the fourth quarter of 2007): Source: businessinsider.com