Everyone is concerned about an overvalued stock market. And they should be. You don't reach a full decade of a bull run without asking the reasonable question about stock values. A simple explanation that Warren Buffett once gave for knowing when the market is overvalued doesn't present a full-throated endorsement of market bargains being plentiful right now.
The Berkshire Hathaway chairman and billionaire investor told attendees at the Berkshire annual conference back in May 1998, only a few months before stocks plummeted, that the easiest way to gain confidence that the market is not overvalued is if two conditions are met: "Interest rates remain at or near present levels or go lower, and that corporate profitability in the U.S. stay at the present — or close to the present — levels," which at the time Buffett was speaking were "virtually unprecedented."
"If the two conditions are met," he said, "I think it's not overvalued. And if either of the conditions is breached in an important way, I think it will turn out to be overvalued."
The comments were actually a reinforcement of what Buffett had written in his annual letter to shareholders the year before.
Anyone who follows the markets knows there are widespread concerns right now that stocks are at peak earnings power. Meanwhile, the Federal Reserve is raising interest rates, and it is not only President Donald Trump blaming it for the recent stock market woes, hedge fund giant Ray Dalio said on Thursday that the Fed is causing asset prices to go down.
It would seem that there is good reason to be reminded of Buffett's words about interest rates. In the late '90s, Buffett also provided a rare presentation at the Allen & Co. conference for industry moguls, in which he said that when interest rates are low, companies get too much easy money and there is no place for investors that makes sense but stocks. Ultimately, the problems will surface and no longer support a rising market. Some of today's tech giants would have been good long-term bets regardless, but about many other stocks, Buffett was right.
Other than his huge stake in Apple — which certainly fits another Buffett mantra, buying great brands that maintain a competitive moat around their value — the billionaire investor hasn't made a major acquisition in years, even though he is sitting on more than $100 billion in cash. The biggest deal he recently made was to buy back near-$1 billion in shares of his own company's stock, a buyback decision he said would be made only at times when he felt Berkshire was trading below its intrinsic value.