There is a lot of talk today about the Buffett Indicator. The Buffett Indicator is the ratio of the market cap of all publicly traded stocks to GDP. Pessimists are saying the Buffett Indicator is predicting a bear market or even a crash. According to the indicator today, stocks are overvalued. There is no question that Warren Buffett has been a brilliant investor, but should we really use this indicator? He is a “bottoms-up” investor, as I am.

But there are more problems with the Buffett Indicator. Almost half the revenues of all publicly traded companies come from overseas sales. The United States represents just 16% of worldwide GDP. So a comparison of American public companies to the US GDP misses 84% of the world GDP. The world GDP is growing faster than the US GDP. The Buffett Indicator misses all of this.

Paul Samuelson wrote the number one textbook for beginning economic students in the 1960s. Chapter one begins by making this point: “the stock market has correctly predicted nine of the past five recessions”. The reason stock prices stumble is that traders and investors believe economic growth is slowing. The longest lasting bear markets have occurred during recessions. Those bear markets which did not coincide with a recession did not last more than three to eight months before recovering.

The Buffett Indicator was correct in 2000 and in 1967. But it missed quite a few others, including the Great Recession. The Buffett Indicator missed the bear of January 1973, November 1980, August 1987, and July 1990. The original use of the Buffett Indicator said if the total market cap was above 80% of GDP then were was a bear market coming. In that case the Buffett Indictor has predicted a bear market for every single year since 2001. Instead of the absolute value, now the tacticians have put a regression slope on the Buffett Indicator which makes no sense whatsoever.

The “illusionary truth effect” is the tendency to believe false information to be correct after repeated exposure. In a 2015 study, researchers discovered that familiarity can overpower rationality. The Buffett Indicator either missed 2/3 of the bear markets in the last 70 years or it has given a false signal 18 times. It does fit the illusionary truth effect. Past history has shown it is not reliable. But that does not seem to bother the technicians who continue to use it.

There are any number of advisors and money managers who claim to time the market, getting out when the market is going down and jumping back ni when it is going up. That sounds so good. But there are no studies that show it can be done consistently over the longer term. For investors, it is a chocolate covered hand grenade. It sounds so good, but when it explodes you’re left with all of the downside and none of the promised benefits.

I often quote the late Jack Bogle, the founder of Vanguard. He said this: “The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently.”

The Index Fund Advisors did a study examining the market for a period of twenty years, between January 1, 1998 through December 31, 2007. If you had invested $100,000 in but were out during the best trading days, here is how your portfolio would be affected: 5,036 days:

Account TotalGainPercentage
5,036 Days$401,350$301,350100%
Miss 5 Days$266,250$166,250-45%
Miss 10 Days$200,300$100,300-67%
Miss 20 Days$125,700$25,700-91%
Miss 40 Days$56,700-$43,400-114%

It’s true that missing the worst days can significantly improve returns. But the question is whether a manager can correctly pick the worst days to be out of the market and pick the best days to be invested. To date, no one knows anyone who has done that successfully and consistently over a long period of time.

Which brings us back to the question of the bear market. Maybe and maybe not. My feeling with the $1.9 trillion stimulus passed and with the economy opening we are not going to face high inflation in the next few years nor are we going to see a bear market.

I accept there will be times when there will be periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare us out of the market. Look at the returns in our growth accounts through 12/31/2020:

AFCS&P 500
2005 Inception13.14%9.75%
I year77.76%16.30%
3 Year35.37%13.48%
5 Year24.62%14.80%
7 Year16.59%11.21%
10 Year16.42%12.67%
Past performance is no guarantee of future results.

In dollar terms, this means that in the actual composite performance of my stock growth account clients, $100,000 became $699,311, while the S&P 500TR grew to just $433,050. Of course, I have to say past performance is no guarantee of future performance. The $699,311 was net to my clients after all fees, costs, and expenses. The results are calculated for each client by independent third party Morningstar. As Peter Lynch said: “I’m always fully invested. It’s a great feeling to be caught with your pants up.”

Check out our videos “Higher Returns Do Not mean Higher Risks” and “A Passion for Creating Wealth” for more information on how AFC creates wealth for our clients.