Stock Markets Are Currently Overvalued And This Market Sentiment Could Precede A Correction

Stock Market Seems to Be On Another Upward Trend
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In the last two weeks, stocks had a touch-go as the increasing ten-year yields impact market sentiment. However, despite this pullback, the closely watched “Buffet Indicator” suggests that the wider market is still pricey.

The current stock market overvalued

Usually, the “Buffet Indicator,” as it is known in Wall Street circles, takes the Wilshire 5000 Index and divides it by US’ annual GDP. Currently, it is hovering around its record high. Considering the numbers, it stands at $187.5%, up from around 175%, when factoring in Q3 GDP data. However, the current record levels are short of the 195.7% record high attained a few weeks back. But, this figure is still high relative to the 159% witnessed before the dot-com bubble.

GuruFocus researchers stated that currently, the stock market is overvalued as per the Buffet Indicator. The researchers added that based on total market capitalization over GPD historical ratio currently, at 187.5%, it is possible to have a -2.5% return a year from now including, dividends.

The ratio became popular following a 2001 Fortune Magazine article by Buffett and Fortune writer Carol Loomis. Despite the ratio having some limitations in telling you what you should know, it is still the best single measure telling you where valuations stand at a particular moment. Therefore, it is not surprising that the indicator is as inflated as it is currently. Over the past year, Federal Reserve liquidity has been running rampant and supported equity markets, but the ongoing pandemic has continued to depress economic output.

In the coming days, the indicator could experience compression in days ahead which suggests potential buying opportunity. Interestingly, Nasdaq 100 could have its worst week in a year as rising 10-yields triggered a sell-off of high growth stocks.

Market excitement could lead to a correction

Over the past week, Dow Jones has lost 1% and currently hovers around 30,000s, with Bitcoin breaking the $50,000 mark. Bank of America and EPFR Global are warning that the latest market excitement could precede a correction. According to a Bloomberg report, EPFR Global and BofA revealed that between February 3 and 10, stock inflows were $58 billion, which is an extremely bullish sign. A note from BofA strategists warns that the resulting market sentiment is likely to trigger a sell signal that has not been witnessed since January 2018.

Wilmington Trust strategist Meghan Shue said that the report shows a concerning trend. Shue said that what is witnessed from the BofA data are record inflows into the US large-cap tech industry. There is less attention given to areas that could offer potential returns in the future. She warned that cash is going off the side-lines, and there is much speculation relative to recent years. Shue is advising retail investors to avoid crypto, big tech, and meme stock buys but instead buy the dip in small-cap stocks, which are likely to outperform large caps by a huge margin in the long term.

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