STREET DOGS

Jody Chudley at Daily Reckoning warns that what Warren Buffett calls “the best single measure of where valuations stand at any given moment” is calling a market top.

Put simply, the Buffett indicator is the total market capitalisation of all US stocks relative to the country’s GDP.

When it’s in the 70%-80% range, it’s time to get in. When it moves well above 100%, it’s time to get out.

At present the metric sits at around 140%, close to the record high of 145% it hit during the peak of the dot-com bubble in 2000 — the only other time it’s been this high.

According to Chudley, however, the reason for the current spike is different to what it was on that occasion. This time it’s about the massive flow of money into passive index funds and exchange-traded funds. Or, as he puts it “too much mindless investing”.

“These passive vehicles buy the exact same stocks with no thought whatsoever given to valuation. If you give an index fund a million dollars it is just as happy to buy stocks trading at 3,000 times earnings as it is to buy stocks trading at six times earnings. This is mindless investing.

“That isn’t an insult by the way. Mindless investing is the stated objective of an index fund. But … when the amount of money managed mindlessly gets to be outrageously large you can see how strange things can result.

“Which is exactly what has happened. Hundreds of billions of dollars have been sucked out of actively managed funds and put into passively managed index funds during this current bull market.

“If you stick your head in the sand and pretend that this isn’t anything to be concerned about, you aren’t going to like what comes next,” warns Chudley. “So don’t … it’s not too late to do something.”