Buffett Indicator: How Much Further Will the TSX Stock Market Crash?

Warren Buffett’s favorite indicator suggests the Canadian stock market is fairly valued. I’m waiting for a bargain.

The S&P/TSX 60 Index, an index of the 60 largest companies listed on the Toronto Stock Exchange, fell 10.6% yesterday. It was the largest single-day stock market crash since 1987, wiping out $298 billion in collective shareholder wealth overnight. The global stock market rout this week is having an impact on everyone, including legendary investor Warren Buffett himself. 

Thus far this year the market has been steadily eroding in value. If you’d invested $10,000 in a low cost index fund at the start of 2020, it would be worth only $8,470 today. Such a rapid loss should make even the most passive investors take a closer look to see whether the market sell-off is over or whether the rout has potential to continue. 

Here’s a look at what Warren Buffett’s favourite stock market indicator says about stock valuations and what impact the oil price is likely to have on Canadian investors in 2020. 

Buffett indicator for stocks

Warren Buffett once said that the ratio of a country’s annual output to the market capitalization of its stock market was the best indicator of valuations. In other words, if the stock market is worth more than gross domestic product (GDP), stocks are overvalued and vice versa. 

The indicator was over 100% for years, which could be the reason why Buffett was hoarding so much cash recently.  

In Canada, the stock market-to-GDP ratio was as high as 137% before the oil market crash of 2015; it’s currently at 105%. That could mean stocks are fairly valued and that investors should consider adding exposure to the TSX index in the near term. However, I believe the sudden drop in oil prices complicates this theory. 

Oil price

The price of crude oil dropped nearly 30% on Monday, marking its biggest drop since the Gulf War erupted in 1991. That’s bad news for Canadian companies and the Canadian dollar. 

Oil and gas companies will bear the brunt of this ongoing price war in the global crude oil market. Heavyweights like Suncor Energy and Enbridge have already lost billions in market value since Monday. Altogether, the energy sector contributes 17.7% of the TSX 60. Also, about 9% of Canada’s GDP is derived from crude oil. 

In other words, we can expect Canada’s GDP to shrink this year if the oil price remains low: a technical recession. This will have a knock-on effect on other businesses. People cut back on spending and the national currency tends to depreciate during recessions, which could mean higher import costs and lower demand for companies like Dollarama or Shopify.  

Investors should probably brace for profit warnings, dividend cuts and perhaps even bankruptcies over the course of this year as corporations adjust to a new reality.  

Foolish takeaway

The Buffett indicators measures the ratio of Canada’s stock market to its GDP. It’s currently at 105% in Canada, which indicates fair value. However, as GDP is expected to fall this year, the market might have to fall even further to remain fairly valued. 

The stock market crash doesn’t appear to be over just yet. Long-term investors should probably wait to buy the dip later. Stay cautious, stay safe, and good luck!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Tom Gardner owns shares of Shopify. The Motley Fool owns shares of and recommends Enbridge, Shopify, and Shopify. Fool contributor Vishesh Raisinghani has no position in any of the stocks mentioned. 

More on Stocks for Beginners

construction workers talk on the job site
Energy Stocks

Best Stock to Buy Right Now: Baytex vs Suncor?

Suncor and Baytex stocks both look like solid companies offering growth and dividends. But which is the better buy?

Read more »

profit rises over time
Top TSX Stocks

3 Reasons to Buy Enbridge Like There’s No Tomorrow

Have you considered buying Enbridge (TSX:ENB)? Here are 3 reasons to buy Enbridge today for lasting growth and income.

Read more »

An investor uses a tablet
Stocks for Beginners

If I Could Only Buy 2 Stocks in the Last Half of 2024, I’d Pick These

I’m looking to buy two stocks over the next month. Here’s a look at my picks and why you should…

Read more »

dividends grow over time
Stocks for Beginners

The Smartest Growth Stock to Buy With $2,000 Right Now

Do you have $2,000 to invest for the long term? These three TSX stocks have and will continue to deliver…

Read more »

The virtual button with the letters AI in a circle hovering above a keyboard, about to be clicked by a cursor.
Tech Stocks

Is OpenText Stock a Buy, Sell, or Hold for 2025?

OpenText stock has fallen in the last few years, but that could mean this top tech stock remains an undervalued…

Read more »

man touches brain to show a good idea
Dividend Stocks

3 No-Brainer REIT Stocks to Buy Right Now for Less Than $200

REITs have long been touted as some of the best dividend stocks out there if you want recurring, strong income.…

Read more »

grow money, wealth build
Dividend Stocks

3 Top High-Yield Stocks to Buy in November

If you want passive income, high yield dividend stocks are the clear choice. These are the best, and safest, out…

Read more »

Stocks for Beginners

Where will Loblaw Stock be in 5 Years?

Want a great food stock that can provide growth and income? Here's why Loblaw stock can offer that and more.

Read more »