Is the Market Flashing Red? 

Warren Buffett isn’t a market timer. Never has been, never will be. Instead, he’s a value hawk, someone who circles the skies looking for bargains and only swoops in when the numbers justify it. In his 1994 letter to shareholders, Buffett put it plainly: “We try to price, rather than time, purchases.”

That simple principle explains why he often appears to be doing… well, nothing. When prices are irrationally high, Buffett is perfectly content sitting on a mountain of cash.

But don’t mistake his patience for inaction. Behind the scenes, he’s watching the same key indicators that tell him whether we’re in bargain territory, or not.

And right now, one of those indicators is screaming.

Key Points

• The Buffett Indicator hit a record 210%, signaling extreme market froth, Buffett is selling, not buying.

• Retail and foreign investment are pulling back, removing key drivers of inflated valuations.

• Unlike pricey megacaps, small-cap stocks offer better value and historical outperformance post-bubble.

Indicator Buffett Made Famous Is at a Record High

“The Buffett Indicator” is the total value of the stock market relative to the country’s gross national product.

He used it to show how dramatically the market had decoupled from economic reality during the dot-com bubble. In 2000, this ratio hit 10 points shy of 200%, a red flag that proved prescient when the bubble burst.

Fast forward to today, and we’ve blown right through that level. The Buffett Indicator recently soared past 210%, eclipsing even its late-2021 peak before the 2022 bear market. Historically, anything above 150% has been considered frothy. We’re in uncharted waters now.

What’s even more telling? Buffett’s own behavior. Over the last 10 quarters, he’s sold more stocks than he’s bought, to the tune of $174 billion in net sales. That’s not the action of a man who sees cheap stocks lying around. He’s also paused Berkshire Hathaway share buybacks, a subtle signal that even he thinks his own company might be fully valued.

Meanwhile, Berkshire’s cash pile is almost $350 billion.

Why the Buffett Indicator Keeps Rising

So why are valuations stretching so far beyond the economy?

Buffett warned us about this decades ago. Even a tiny move in interest rates can dramatically affect asset prices. For most of the 2010s, interest rates hovered near zero, effectively making cash unattractive and pushing investors into equities, no matter the valuation.

Though rates have ticked up in the past few years, the long-term average remains historically low, which still incentivizes risk-taking. But if rates stay higher for longer—as many now expect—valuation multiples may need to come down to earth.

Stock ownership among U.S. households surged to a record 43.1% in 2024, up from just under 20% in 2009. That massive increase helped push up market caps far faster than the economy grew.

But here’s the wrinkle because in Q1 of this year, household equity ownership dipped for the first time in years. It’s subtle, but notable.

As of mid-2024, foreign investors held a staggering $17 trillion in U.S. stocks. That’s up tenfold from 2000. Back then, they accounted for less than 12% of the Wilshire 5000. Today? Over 30%.

But political risk is creeping back into the picture. After President Trump’s renewed tariff threats earlier this year, some foreign investors started pulling capital from U.S. markets. If that trend accelerates, it could put downward pressure on valuations, fast.

Should You Panic?

The Buffett Indicator isn’t a crystal ball. It won’t tell you when the market will crash, or if it will at all. But what it does offer is context. It tells us how much investors are paying for each dollar of economic output.

Right now, we’re paying more than ever. Buffett’s own actions reinforce this caution. He’s not buying aggressively, even as Wall Street cheers every new all-time high. That should make investors pause.

But it doesn’t mean you should hit the sell button and move to cash. Instead, it’s a reminder to be selective.

Where to Look When Valuations Are Sky-High

One reason the Buffett Indicator has climbed so much is the sheer size of a few tech behemoths. A handful of companies, think Apple, Microsoft, Nvidia, are now worth more than entire sectors used to be. Strip them out, and valuations across the broader market aren’t quite as extreme.

That’s especially true in small-cap stocks. Back in 2000, small caps were left out of the dot-com euphoria. And guess what? The S&P 600 outperformed the S&P 500 over the next decade. While tech giants floundered, smaller companies quietly delivered steady gains.

Today, a similar dynamic may be unfolding. Many small and mid-sized businesses are trading at attractive valuations, with solid fundamentals, but without the AI hype premium.

If you’re looking to protect your portfolio from sky-high valuations, don’t follow the crowd. Follow the value. That means digging into the overlooked corners of the market, where prices are still grounded in reality. Buffett would approve.

Final Thoughts

Patience isn’t just a virtue, it’s a strategy. Buffett has shown time and again that waiting for the right pitch is better than swinging at every ball. The Buffett Indicator might be signaling caution, but it’s also flashing opportunity for those willing to look beyond the obvious.