Warren Buffett's Favorite Valuation Metric Is Ringing an Alarm

"It highlights the remarkable mania we are witnessing in the U.S. equity market," said Michael O'Rourke, chief market strategist at JonesTrading. "Even if one expected those (Fed) policies to be permanent, which they should not be, it still would not justify paying two times the 25-year average for stocks."

Multiple Indicators Exceeding Previous Records

This detachment of the Buffett indicator from its long-term trend joins an assortment of other valuation metrics that have exceeded their previous records in the rebound from the pandemic-induced bear market last year — if not years earlier.

Price-to-earnings, price-to-sales and price-to-tangible-book value are among the metrics firmly above dot-com era levels that many investors assumed were once-in-a-lifetime peaks.

Rising valuations are famously bad tools for timing market tops. Indeed, all tools are. For now, many investors are confident to bet that the recovery from the pandemic will boost some of the denominators in ratios like these, so they're not letting valuations scare them off.

The S&P 500 gained 1.2% for the week to close at a record amid a pickup in vaccine distributions and progress on a new fiscal stimulus package. Energy, the best-performing sector this year, led the advance, adding 4.3%.

Rising Bond Yields vs. S&P 500 Earnings Yield

Meanwhile, the yield on 10-year Treasuries hit 1.20% on Friday, the highest since the pandemic-induced crash last year. Interest rates are still unlikely to be approaching a level that would undermine the bull case for stocks, given the S&P 500's earnings yield is 3.1%.

Speaking to the Economic Club of New York this week, Fed Chair Jerome Powell re-emphasized that the central bank's stimulative policies will not be dialed back anytime soon.

"When you compare it to fixed income markets, and with the rates where they are, the earnings yield for stocks is still positive," said Anu Gaggar, senior global investment analyst for Commonwealth Financial Network. "And now with the Fed keeping rates at these low levels, that just gives comfort to the market."

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