With the stock market trading reaching a historic high, Warren Buffett's favorite valuation Indicators have also reached a new peak.

On Monday, the "Buffett Indicator," which measures the total Market Cap of US stocks against US GDP, reached about 209%, a historic high that exceeds the 200% record set in August 2021. Buffett introduced the indicator in an article in 2001.

In other words, the total Market Cap of the US stock market, measured by the Wilshire 5000 All Market Index, is approximately $61 trillion, more than twice the annualized GDP of the USA, which is about $29 trillion.

Bearish investors quickly pointed out that the "Buffett Indicator" is another signal that the stock market is severely overvalued and should be corrected. However, research from Morgan Stanley suggests that this indicator may not be the best valuation tool.

Michael Mauboussin from Morgan Stanley Counterpoint Global pointed out two flaws in the "Buffett Indicator."

Mauboussin said, "First, compared to past decades, US companies now generate more sales from outside the USA. This means that the numerator of this indicator (i.e., Market Cap) reflects the potential market better than the denominator (i.e., GDP)."

Considering that about 40% of the revenue from S&P 500 Index constituent companies comes from international markets, if this revenue were accounted for in US GDP, the "Buffett Indicator" would not send such a strong warning signal as it does now.

The second question is about the significant differences between the economy now and in the past.

Mauboussin said: "Due to GDP's failure to accurately measure the quality of goods and services as well as the value of new goods and services, the USA's GDP may be underestimated. The rise of digitalization makes measurements today more challenging than in the past."

The GDP-based stock market valuation indicators may have been more accurate decades ago when manufacturing accounted for a larger share of the USA economy, but this is no longer the case today.

Blackrock and economist David Rosenberg's recent research also echoes this viewpoint.

Blackrock stated last week: "The changes in the composition of the stock market sectors reflect the ongoing transformation. Therefore, comparing today's index with the past is like comparing apples to oranges."

Meanwhile, Rosenberg stated last week that he recalibrated his long-term Put outlook due to the evolution of the USA's technology-focused economy.

Mauboussin analyzed the Buffett Indicator and concluded that valuation indicators that were effective in the past may not be suitable for the current market.

Mauboussin said: "Like most indicators, we need to use caution when comparing the present with the past."

It is worth noting that Buffett himself does not believe that the stock market valuation indicators he proposed can fully determine the right timing for investment.

At the Berkshire Hathaway shareholders' meeting in 2017, when asked about his views on valuation indicators such as the "Buffett Indicator", Buffett said: "Every number has a certain degree of significance, sometimes the significance is greater, and sometimes they are almost completely unimportant. It is not as simple as having one or two formulas and then saying whether the market is undervalued or overvalued."

However, given that Berkshire Hathaway holds over 300 billion dollars in Cash / Money Market, investors and market observers speculate that Buffett is concerned about the current valuations of the US stock market.

Editor/lambor