Warren Buffett seems to think there is a bubble in the US; What does he know we don’t know?

Over the past five years, Americans have seen action markets soak. Last month, the S&P 500 reached a historical record of 6,144 points, an increase of over 89% since January 2020. This vertiginous growth in the value of US stocks rekindled the choir of analysts warning about a possible “bubble”.

The term “bubble” is popular, but in reality it is poorly defined and inaccurate. In theory, it refers to periods when asset prices are far above what would be justified by their foundations. Many economists, however, question this notion.

Peter Garber, author of “, argues that bubbles are just a rhetorical device to describe“ crazy ”markets and justify greater regulation. The Nobel Eugene Fama Award, considered the “father of modern finances”, also criticizes the concept, claiming that if bubbles actually existed, large increases in stock prices should predict lower returns in the future – something that, he said, usually does not occur. Research from Harvard economists such as Robin Greenwood, Andrei Shleifer and Yang You support part of this view, but indicate that the nature of an asset can, in fact, predict a future collapse.

Buffett is accumulating cashier

So is the US stock market in bubble territory? Renowned investors like Warren Buffett seem to believe yes. The percentage of cash in the Berkshire Hathaway balance has reached a 27% record in the last quarter, and Buffett even got rid of all the ETFs that accompany the market.

To evaluate if we agree with Buffett, we use Dr. X’s bubble detector – a concept described in a August 1996 letter sent to one of us (Hanke) by a late Nobel Prize in Economics.

Dr. X’s Bubble Detector is calculated from the ratio between wealth and income for actions, divided by the same reason for securities. This metric indicates the time required for a constant flow of income to “buy” a particular asset – for example, 1,000 Apple actions or 1,000 US Treasury titles. The longer the reason, the longer it is necessary to purchase these assets, suggesting that they are becoming more expensive in relation to available income.

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Bubble detector reading increases when the rich/income ratio for actions rises in relation to the same reason for securities. In other words, warning signs appear when it becomes significantly more expensive to buy $ 1 profit from stock than buy $ 1 income with securities.

As an indicator of the richness/income reason for action, Dr. X used the relationship between S&P 500 and per capita income in the US. If stock prices rise as income remains stable, reason grows, indicating a more expensive market. In December 2024, this metric was 5,881.6/73,259, or 0.08. For titles, the proxy used is the inverse of the 10 -year treasuries rate, or 1/(interest rate). This value was at 1/4.569, or 0.219. Bubble detector is then obtained by dividing these two reasons: 0.08/0.219 = 0.3655.

Bubble detector had an average of 0.141 since January 1987. Before the Internet bubble in the early 2000s, it reached a peak of 0.3229. Since then, it has fallen to 0.0536 in September 2012 and even more, to 0.0306, at the beginning of the Covid-19 pandemic.

All signs of a bubble

The drop in Dr. X’s bubble detector at the beginning of the pandemic illustrates how this metric responds to market conditions. The S&P 500 fell 20%, while the 10 -year Treasuries rate was halved. As a result, the reason for rich/income for securities rose and for actions fell. The bubble detector signaled that it was a great time to buy stocks – and it was right.

The current level of the detector – a record of 0.3655 – is the product of the opposite dynamic. The stock market has fired in the last five years, driven by the injection of money by the Fed during the pandemic and the enthusiasm around artificial intelligence. At the same time, inflation resulting from the excess of monetary stimuli increased the income from government titles. Thus, we saw the opposite of what happened at the beginning of COVID-19: the rich/income reason for titles fell, while for actions it rose.

What we are seeing now has all the ingredients of the late 1990s internet bubble, which burst in 2001. The last time the bubble detector came close to the current level was precisely before the collapse of the Dot-Com bubble when it reached 0.3249.

The Nobel Prize Robert Shiller argued in IrRational Exuberance that bubbles are psychological phenomena created by a combination of factors: a new technological advance, rumors about people rapidly enriching and intense media coverage by reinforcing this cycle.

Trying to predict the “top” of the market is always risky – no one has a crystal ball. But ignoring a good signal can also be a mistake. Dr. X’s Bubble Detector indicates that Buffett may be right: there is something very inflated in the US stock market.