As investors settle into 2023, the U.S. stock market remains modestly overvalued based on Berkshire Hathaway Inc. (BRK.A, Financial)(BRK.B, Financial) CEO Warren Buffett (Trades, Portfolio)’s favorite market indicator. On the other hand, several European markets are undervalued based on the ratio of total market cap to gross domestic product.
U.S. market begins the new year with a strong first week
On Monday, the Dow Jones Industrial Average closed around 33,517.65, down 112.96 points from the previous close of 33,630.61.
The Dow finished last week up 1.5% on the back of a 700-point gain on Friday as investors track progress from the Federal Reserve’s interest rate hikes. While nonfarm payrolls increased 223,000 in December 2022, topping consensus estimates, average hourly wages increased by just 0.3% during the month and 4.6% during the past year, below the consensus estimates of 0.4% monthly growth and 5% annual growth.
According to the Aggregated Statistics Chart, a Premium feature of GuruFocus, the mean one-week return of the Standard & Poor’s 500 index stocks is 3.41% with a median of 3.04%.
U.S. market remains overvalued based on Buffett’s indicator
Buffett opinioned that the ratio of total market cap to gross domestic product is “probably the best single measure of where valuations stand at any given moment.” GuruFocus modified the ratio by including the total Federal Reserve Bank assets to the denominator.
As of Monday, the market valuation ratio for the U.S. stands at 113.5%, based on a Wilshire 5000 full cap index of approximately $39.05 trillion, gross domestic product of approximately $25.72 trillion and total Federal Reserve Bank assets of approximately $8.55 trillion.
Based on the current market valuation level, the implied market return for the U.S. market is approximately 3.5% per year over the next eight years assuming a reversion to the 20-year median market valuation ratio of 94.07%.
The predicted and actual returns chart also tracks an optimistic case at 130% of the 20-year median ratio and a pessimistic case at 70% of the 20-year median ratio. Based on this chart, the implied market valuation for the U.S. market ranges between -0.8% per year and 5.3% per year.
Other valuation methods exist for the US stock market
For the U.S. stock market, GuruFocus also tracks alternative measures including the Shiller PE and the GF Value for the S&P 500 index.
Yale Professor Robert Shiller measures valuations based on the cyclically-adjusted price-earnings ratio. The Shiller PE ratio considers earnings over the past 10 years and adjusts the earnings based on the consumer price index.
As of Monday, the Shiller PE for the S&P 500 is 28.2, approximately 8.5% higher than the 20-year mean ratio of 26. Based on the Shiller PE market valuation, the implied market return of the U.S. market is approximately 4.8% per year.
GuruFocus’ GF Value measure considers historical price multiples and adjusts for past performance and future growth estimates. On Monday, the S&P 500 closed at 3,892.09, showing the index is modestly undervalued based on its price-to-GF Value ratio of 0.87.
GuruFocus also extends Buffett’s market indicator concept to other regions
GuruFocus also tracks the ratio of total market cap to gross domestic product for other subscription regions, including Europe, Asia, U.K., Oceania and Canada.
For each country, the market valuation ratio applies the country’s total market cap, gross domestic and total central bank assets and compares the ratio to the historical average. The implied market return assumes a reversion to the historical average market valuation ratio.
According to the Global Projected Market Return chart, several European stock markets are undervalued based on the Buffet indicator, including the stock markets in Spain, Belgium, Italy, Germany and Switzerland.
The Buffett indicator for the Spain stock market stands at 26.81%, showing the stock market is significantly undervalued compared to the 20-year minimum ratio of 22.39% and the 20-year maximum ratio of 110.25%. The implied market return for the Spanish stock market is approximately 15.2% per year assuming a reversion to the mean ratio of 55.59%.
Belgium
The Buffett indicator for the Belgium stock market stands at 36.26%, showing the stock market is modestly undervalued compared to the 20-year minimum ratio of 23.01% and the 20-year maximum ratio of 77.62%. The implied market return for the Belgian stock market is approximately 12.8% per year assuming a reversion to the mean ratio of 52.01%.
Italy
The Buffett indicator for the Italy stock market stands at 18.39%, showing the stock market is modestly undervalued compared to the 20-year minimum ratio of 12.67% and the 20-year maximum ratio of 46.9%. The implied market return for the Italian stock market is approximately 9.9% per year assuming a reversion to the mean ratio of 24.86%.
Germany
The Buffett indicator for the Germany stock market stands at 29.68%, showing the stock market is modestly undervalued compared to the 20-year minimum ratio of 20.77% and the 20-year maximum ratio of 53.29%. The implied market return of the German stock market is approximately 8% per year assuming a reversion to the mean ratio of 46.65%.
Switzerland
The Buffett indicator for the Switzerland stock market stands at 110.97%, showing that the stock market is modestly undervalued compared to the 20-year minimum ratio of 93.63% and the 20-year maximum ratio of 241.89%. The implied market return of the Swiss stock market is approximately 7.9% per year assuming a reversion to the mean ratio of 132.25%.
