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The Warren Buffett indicator looks at the total value of the stock market compared to the country’s GDP. (Pexels/ Representative image)
Buffett indicator signals market may be overvalued
The Warren Buffett indicator looks at the total value of the stock market compared to the country’s GDP. Investors use it to see whether stock prices are high or low compared to the real economy.
Over the past 10 years, the indicator usually stayed between 110% and 150%, which suggested markets were fairly priced or slightly expensive. Now, it has moved far above that level.
This suggests investors are placing heavy weight on future earnings expectations. That can increase the risk of short-term volatility, particularly if companies fail to meet profit targets or if investor sentiment shifts suddenly.
Several large institutions have warned about possible turbulence ahead. Capital Economics has cautioned that the S&P 500 could face a double digit decline. Goldman Sachs has issued similar projections if earnings growth slows.
These warnings have added to fears that a broader market correction or even a deeper downturn in 2026 may be possible.
Investors look to Buffett strategy as valuations stay high
When valuations become stretched, Warren Buffett typically builds up cash reserves. Holding cash helps cushion against volatility and provides funds to invest when markets decline.
But at the same time, not every stock is highly priced. Some companies in the S&P 500 still look reasonably valued.
One example is Trex (NYSE:TREX). The stock has dropped more than 35% in the past year and now trades at a price-to-earnings ratio of 23, lower than its long-term average of 33.
The company has faced challenges. Higher interest rates in the US and UK have slowed demand for home improvement projects. Inventory reductions and pressure on profit margins caused it to miss earnings targets in 2025, which hurt the share price.
However, Trex remains the global leader in composite decking. With interest rate cuts expected and inventory pressures easing, the company could be set for a recovery.
As Buffett has said many times, “the time to be greedy is when everyone else is fearful.”
Investors are now waiting for its next earnings report. If there are early signs of improvement then the stock could become an attractive option, even while overall market valuations remain high.
