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Buffet Indicator for Macro Trends

Investopedia recently came out with an article on Warren Buffet’s barometer for gauging stock market valuations and how it currently shows an extreme overvaluation of the market. The “Buffet Indicator” is the ratio of market capitalization of all publicly-traded U.S. stocks to U.S. GDP. The article states that when the ratio is between 70%-80% it safe to put in stocks, 100% means danger and 140% means extreme danger. We are currently at a record high of 138%.

I thought it would be interesting to gauge the performance of this indicator using the historical data provided by QuantConnect and see how well it predicted previously overvalued markets. In the algorithm below I would stay invested in the SPY until the ratio reached the danger mark or 100%, and exit until the markets were not overvalued.

Sources:

https://www.investopedia.com/news/buffett-indicator-spells-bad-news-stock-investors/

http://longtermtrends.net/market-cap-to-gdp/

Update Backtest






The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by QuantConnect. In addition, the material offers no opinion with respect to the suitability of any security or specific investment. QuantConnect makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances. All investments involve risk, including loss of principal. You should consult with an investment professional before making any investment decisions.



The basic strategy using the Buffet Indicator ended up not working as well as I hoped. There were some long flat periods and during the 2008 market crash the indicator went below 1 so we took a large loss. I created another strategy using what I learned with the mindset of still being a risk-averse investor but also riding the trends of the Buffet Indicator. If the market was overvalued or the market value was falling I stayed in AGG, otherwise, I invested in the QQQ. Due to the inception dates of the ETFs used, I was only able to back test to 2003. The results below pleasantly handled the 2008 market crash. It will be interesting to see how the “overvalued” stock market plays out in the coming months.

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The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by QuantConnect. In addition, the material offers no opinion with respect to the suitability of any security or specific investment. QuantConnect makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances. All investments involve risk, including loss of principal. You should consult with an investment professional before making any investment decisions.


Update Backtest





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The material on this website is provided for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation or endorsement for any security or strategy, nor does it constitute an offer to provide investment advisory services by QuantConnect. In addition, the material offers no opinion with respect to the suitability of any security or specific investment. QuantConnect makes no guarantees as to the accuracy or completeness of the views expressed in the website. The views are subject to change, and may have become unreliable for various reasons, including changes in market conditions or economic circumstances. All investments involve risk, including loss of principal. You should consult with an investment professional before making any investment decisions.


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