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Buffett Indicator Flashing A Warning Sign That The U.S. Stock Market is Strongly Overvalued

• The Buffett Indicator is the ratio of the total United States stock market to the economy (GDP). 
  
• As of January 2025, the Buffett Indicator sits above 200%, signaling that the U.S. stock market is historically overvalued compared to the underlying economy. 

What you need to know:  The Buffett Indicator compares the Wilshire 5000 Index to U.S. GDP. It is now at 202%, surpassing its previous peak from November 2021. Warren Buffett once called it "the best single measure of valuations."¹ 

Why it matters: If stock prices rise much faster than the economy, it can signal a market bubble. Think of the Buffett Indicator as a macro P/E (price-to-earnings) ratio for the entire market - just as a company with a high P/E ratio may be overvalued, the same logic applies when stocks significantly outpace economic growth. 

Now the Dunham Deep Dive: The Buffett Indicator is a simple but powerful way to gauge whether stocks are overpriced or undervalued relative to the economy.

The formula is pretty basic: take the Wilshire 5000 Index ÷ U.S. GDP × 100 = Buffett Indicator %

Thus, according to the latest reading, it's now over 200% - marking an all-time high.

Put another way, it essentially means that the stock market is valued at over 2x the size of the economy.

Now, there are two ways of looking at this. . .

On the one hand, markets continue expecting significant future GDP growth and are pricing stocks accordingly. Thus investors are willing to pay more now, assuming economic expansion will catch up.

However, on the other hand, markets may have outpaced corporate profits and economic fundamentals. And if history is any guide, returns could correct sharply when reality sets in.

Can stocks and profits keep rising? Absolutely - they have for years.

But at these valuations, any slowdown in growth could trigger a steep pullback.

And historically speaking, market drawdowns tend to be very sharp after prolonged run-ups (see chart below).

Just something to keep in mind. 

Figure 1: LongTermTrends, February 2025 

China’s Economy at Risk? Why the Latest U.S. Tariffs May Hit Harder Than You Think 

• The U.S. has imposed a sweeping 10% tariff on all Chinese imports - but China’s response has been far weaker, revealing a key vulnerability in its economy. 
  
• With China’s economy already struggling, losing its biggest buyer at this critical moment could trigger ripple effects across global markets.
  

What you need to know: On February 1, 2025, President Donald Trump signed an executive order imposing a 10% tariff on all imports from China, effective February 4, 2025. This action aims to address concerns over illegal drug trafficking and trade imbalances. 

Why it matters: For decades, the United States has been China’s largest export market, importing more Chinese goods than any other country. As a result, tariffs disproportionately impact Chinese exporters more than their U.S. counterparts, as they rely heavily on American demand. This could negatively hurt Chinese manufacturers. 

Now the Dunham Deep Dive: I know I’ve given you plenty of material on the brewing trade war, but it’s impossible to ignore as tensions rise.

China faces a growing dilemma. Its export-driven economy depends heavily on U.S. consumers - who consistently outspend the rest of the world.

To put this into perspective:

• 15% of China’s total exports go to the U.S. - roughly double the second-largest recipient, Hong Kong (8%)².
• Certain sectors are highly exposed to U.S. demand – such as consumer electronics (22% of total exports), home appliances (19%), and textiles and clothing (17%).

And while U.S. consumers may pay more initially as domestic supply adjusts, these tariffs will likely hit China’s economy harder - especially now.

China is already struggling with a 2008-style housing crisis and weak domestic demand. To compensate, they’ve been doubling down on exports (I’ve written about this before – read here). But with their biggest buyer pulling back, this could weaken China’s economy even further - at the worst possible time.

• China’s trade surplus - the gap between exports and imports - hit nearly $1 trillion last year, highlighting the country’s weak domestic consumption and growing dependence on exports.
  
  In fact, exports and the construction of new factories to grow them are practically the only areas of strength in China’s economy amid broader struggles. . .

So, how did China react to the U.S. tariffs? Unsurprisingly, China responded immediately - but with far smaller tariffs of their own.

For instance, U.S. tariffs impact over $500 billion worth of Chinese goods. But China’s tariffs? Just $14 billion of U.S. goods³. That’s only 2.6% of what the U.S. is taxing.

Why such a small response? Because China imports far less from the U.S. than what they export to the U.S. (China runs a $300 billion net-trade surplus with the U.S.) – thus giving them fewer targets for retaliation - and more to lose in a prolonged trade war.

That’s why whenever the U.S. mentions tariffs, foreign currencies like the Chinese yuan sink - while the U.S. dollar strengthens. Because these policies disproportionately impact export-driven economies.

Just something to keep in mind when watching geopolitics and macro trends.

Figure 2:  Visual Capitalist, February 2025 

Markets Thrive on Liquidity: Why Easing Financial Conditions Matter for Stocks and Borrowing 

• The Goldman Sachs Financial Conditions Index (GSUSFCI) sits at 99 - signaling that borrowing costs, credit availability, and stock market conditions remain fairly loose - even with higher interest rates. 
  
• Historically, market sell-offs occur when conditions tighten, while bull markets thrive when liquidity expands - meaning this trend could be a key driver of economic and market performance.

What you need to know: The latest Goldman Sachs U.S. Financial Conditions Index (GSUSFCI) is currently around 99 - meaning financial conditions are slightly looser than average. This suggests that borrowing costs, stock market performance, and credit availability are not overly restrictive even with higher rates, and have been easing over the past few months⁴. 

Why this matters: Financial conditions affect everything from mortgage rates to business loans and stock prices. A reading like this means the economy isn’t under extreme stress and conditions are easing, but if the index rises significantly, it could signal tighter credit and slower economic growth. 

Now the Dunham Deep Dive: Understanding financial conditions is key to gauging whether liquidity is tightening or loosening. And since the global economy post-1980s is dependent on credit, this is pretty important to follow.

But with so many factors - like interest rates, credit spreads, stock prices, and exchange rates - how do you simplify it?

That’s where the Goldman Sachs Financial Conditions Index (GSUSFCI) comes in. It combines these variables into a nice, single measure - making it easier to gauge liquidity trends.

Here’s how it works:

• The index is based on 100, representing the historical average.
  
• Anything above 100 = tighter financial conditions (such as higher borrowing costs, lower risk appetite, and reduced liquidity).
  
• Anything below 100 = looser financial conditions (such as easier credit, higher market liquidity, and increased risk-taking).

Keep in mind that historically, market sell-offs occur when financial conditions tighten, while bull runs thrive when they loosen - which makes sense, as cheap debt and liquidity fuel asset prices, spending, and growth. And vice versa when conditions are tight.

So, right now, with the GSUSFCI index at 99 - conditions point to liquidity staying fairly loose.

• Borrowing is more accessible, credit markets are stable, stock valuations support growth, and the strong U.S. dollar isn’t causing major financial strain.

Meanwhile, the Fed started cutting rates in September, so conditions should continue to ease.

But a sudden rise in inflation, widespread bankruptcies, or pessimistic market sentiment could change that.

Either way, it’s something to watch.

Figure 3:  MacroMicro, January 2025

Anyway, who knows what will happen?

This is Just some food for thought as we watch how these trends develop.

As always, we’ll be keeping a close eye on things. Enjoy the rest of your weekend.

Sources:

1. The Buffett Indicator: Market Cap to GDP - Updated Chart | Longtermtrends
2. Visualizing China's Dependence on U.S. Trade
3. Xi’s Careful Reply to Trump Tariffs Shows China Has More to Lose - Bloomberg
4. https://www.isabelnet.com/fed-gs-u-s-financial-conditions-index/

Disclosures:

This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance. All examples are hypothetical and are for illustrative purposes only.

Information contained in the materials included is believed to be from reliable sources, but no representations or guarantees are made as to the accuracy or completeness of information. This document is provided for information purposes only and should not be considered as investment advice.

The Goldman Sachs Financial Conditions Index (GSUSFCI) - is a weighted average of financial variables that measures the strength of the US economy. It's used to gauge the overall tightness or looseness of financial conditions. Goldman Sachs produces its FCI using a dynamic macroeconomic model to determine the relative weights of five underlying indicators: a policy rate, a long-term riskless bond yield, a corporate credit spread, a measure of equity valuations, and a trade-weighted exchange rate.

Investors cannot invest directly in an index.

Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/Dealer. Member FINRA/SIPC. Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc.