I like to frequently point out that the advice given by Warren Buffett is the opposite of what actually made Buffett extremely rich.  This doesn’t automatically make the advice wrong, but it is important to recognize it.

Buffett is a strong advocate (for others) to buy and hold U.S. stock market index funds.  He says if you believe in the American economy, then it is a relatively safe bet to just buy a low-cost index fund of the S&P 500 and hold on to it for the long run.

However, Buffett became extraordinary wealthy by picking individual companies to buy or invest in.  He found companies that he saw as good long-term value plays.  For the most part, he has been quite successful in the strategy that he has personally implemented. He isn’t exactly a rags-to-riches story, but you could say he is a story of going from upper middle class to one of the wealthiest people on the planet.

Warren Buffett’s father – Howard Buffett – was a Republican congressman.  Philosophically, Howard Buffett was mostly libertarian.  He advocated a non-interventionist foreign policy, and he pushed for a return to the gold standard.  Unfortunately, Warren Buffett did not follow in his father’s footsteps, at least politically speaking.

There have been some recent stories discussing Warren Buffett’s favorite metric in telling us of stock valuations.  Buffett has, in the past, cited this indicator as “the best single measure of where valuations stand at any given moment”.

The indicator is the total market capitalization of all U.S. stocks divided by the latest GDP.

Of course, like any indicator, it doesn’t have to be right, and Buffett himself would tell you this.  We don’t hear Buffett currently out on the circuit warning of a major stock market downturn.  Even if he thought such a thing was coming, he probably wouldn’t boldly announce it.

The Buffett indicator is currently near 150%.  It is at about the same level as the peak in 2000 at the height of the tech bubble.  The current number is well above the percentage in 2008 before stocks (and the rest of the economy) imploded.

In other words, if the Buffett indicator is to be trusted, then we should be seeing a massive selloff in U.S. stocks in the near term.  Also, in other words, you shouldn’t be following Buffett’s advice to buy and hold an index fund.

Even if you do want to bet on the long-term health of the U.S. economy, why would you hold on to a heavy stock position when you know that there is a high likelihood of a severe correction?  If you trust Buffett’s advice to buy and hold stocks, then why do you not trust his advice with his favorite indicator of stock valuations?

It’s possible that GDP could spike higher and bring down the currently high percentage of the indicator.  But really, how likely is that?  If the indicator means anything and is likely to fall back below a more reasonable level of, say, 100%, then this is far more likely to come about with a major correction in stock prices.

I think the Buffett indicator is an interesting one and certainly has some merit.  Still, I believe that it is not the best indicator overall.  The best indicator is the yield curve.  An inverted yield curve is about as certain as it comes when predicting a recession.  And with the major explosion in stocks over the last several years, it is almost certain that a major correction in stocks would go along with a recession.

Currently, the yield curve has not yet inverted.  It has flattened quite a bit in the last year.  As I write this, there is less than a one percentage point difference between the 10-year yield and the 3-month yield.

The yield curve is my indicator.  But either way, I am not an advocate of buying and holding index funds in U.S. stocks.  I advocate a permanent portfolio.  And if you think there is strong likelihood of stocks severely correcting, why would you hold them anyway?  You can always buy them back after the correction.