BIS-IMF: The ‘Buffett Indicator’ and fears of a market storm

The famous Buffett Indicator has climbed to a dangerous 236% of US GDP, far surpassing the record highs of the dotcom bubble and renewing concerns that global markets may be on the brink of a sharp correction.

This extreme concentration of capital in a handful of technology stocks, combined with the swelling leverage of hedge funds, creates an explosive cocktail for global liquidity.

This international instability is also testing the Athens Stock Exchange, despite its recent historic upgrade to developed-market status and the low valuations of Greek shares.

Global markets

An imported crisis, such as the subprime crisis of 2007, could trigger a mass deleveraging by foreign institutional investors. That would send shockwaves through Greece’s bond and equity markets, with negative consequences for economic liquidity and growth.

In the trading rooms of New York and London, the glowing screens of the terminals project an image of unalloyed triumph, as investment fervour for artificial intelligence pushes leading stock market indices to successive record highs.

A few metres away, behind the heavy doors of the risk management departments, the mood is quite different. There, executives are watching with concern as 10-year bond yields steadily climb under the weight of fiscal deficits across the Western world.

This unprecedented divergence between stock market euphoria and the pressing reality of borrowing costs is the biggest economic paradox in decades.

At the heart of this global imbalance, regional capital markets such as the Athens Stock Exchange are finding that even the most fortified investment havens remain exposed when large international portfolios are forced to deleverage abruptly.

The starkest warning about the fragility of market balances and valuations comes from Basel, Switzerland. In its latest quarterly review, the Bank for International Settlements — the leading institution known among market participants as the “bank of banks” — says the market rally rests on assumptions that verge on excess.

The big debate

At the heart of the report’s findings is the historic Buffett Indicator, which compares the total market value of US shares with the gross domestic product of the United States.

The Buffett Indicator has surged to 236% of US GDP. This is far above the peak of the technology bubble in 2000, when the indicator was approaching 150%, and the levels seen in 2008, shortly before the collapse of Lehman Brothers.

At the same time, figures published by the Federal Reserve show an unprecedented concentration of systemic risk. Just 10 corporate giants now account for 38.85% of the total weighting of the S&P 500, with a combined market capitalisation of more than $24tn. This turns the global stock market benchmark into an extraordinarily concentrated bet.

By contrast, supporters of the rally argue that traditional measures cannot capture the modern digital reality. They point out that US technology giants now generate more than 40% of their revenue outside the country, making GDP an inadequate basis for comparison.

Moreover, unlike the loss-making companies of the dotcom era, today’s market leaders generate substantial cash flows. Net profit margins are often above 35%, demonstrating that their profitability is underpinned by genuine, global-scale monopolies.

Accounting distortions

Beyond the disagreements among analysts, a deeper accounting distortion is distorting the true picture of earnings.

In a special study, analysts at the CFA Institute explain that US GAAP requires research and development spending to be recorded immediately as an operating expense in the current period.

This immediate expensing temporarily depresses companies’ net profits, making price-to-earnings multiples appear artificially inflated. If spending on software and algorithms were capitalised like industrial facilities, P/E ratios would be much closer to historical market averages.

However, the same CFA Institute study highlights the reverse — and clearly more dangerous — side of this practice. While software costs are expensed immediately, huge physical investments in data centres, energy infrastructure and AI processors are capitalised on balance sheets as usual and depreciated gradually over three to five years.

This is precisely where the biggest landmine for profitability in the coming years lies. If the breakneck pace of innovation makes current generations of processors obsolete in two years rather than four, companies will be forced to make large-scale impairments of fixed assets, triggering a sudden collapse in net earnings and cash flows.

Shadow leverage

While public attention remains fixed on Silicon Valley balance sheets, authorities concerned about the stability of the global system are turning their focus to non-bank financial institutions.

In its latest Global Financial Stability Report, the International Monetary Fund is sounding the alarm over the activities of leveraged hedge funds.

The Fund’s analysis shows that although these funds manage just 5% of global non-bank financial assets, the synthetic leverage they create through derivatives and repurchase agreements exceeds $40tn in notional value. This huge volume of transactions turns individual mistakes into cascading reactions.

The IMF’s findings show that equities held by these funds can be up to 10 percentage points more volatile during periods of market stress.

“Overall leverage acts as a multiplier of panic in times of crisis,” the authors of the IMF report say.

A case in point was the liquidity crisis at specialist fund Situational Awareness, which lost 67% of its assets under management in just a few days because of asymmetric positions in derivatives. The incident forced prime brokers to liquidate positions in a co-ordinated move, revealing the scale of the risks.

When demand for additional risk protection rises in major financial centres, a direct channel for the crisis to spread is activated. As history has shown, to cover their dollar positions immediately, international managers sell not their losing securities but their most profitable positions in peripheral markets.

Greek resilience

The Athens Stock Exchange has a place in this picture. According to recent data published by ELSTAT, real GDP grew by 1.9%, significantly outperforming the anaemic eurozone average of 1.2%.

At the same time, figures in the Bank of Greece’s Financial Stability Report confirm fiscal discipline, with the primary surplus reaching 2.2% and the public debt-to-GDP ratio falling to 136.1%, helped by early repayments of intergovernmental loans.

The Greek stock market’s official entry into developed-market status was marked by record daily trading turnover of €4.26bn during the recent rebalancing of international indices. The development confirmed the return of major long-term institutional portfolios to the Athens market.

At the same time, valuations remain attractive, with the general index on Euronext Athens trading at a forward earnings multiple of about 11.2x, against 14x for the European Stoxx 600 and more than 22x for the US S&P 500. Greek systemic banks, meanwhile, have P/TBV ratios of between 0.7x and 0.9x, providing strong capital buffers.

The resilience test

However, the Bank of Greece leadership is clear that strong fundamentals are no absolute shield against international shocks.

Except on days when turnover is elevated because of index rebalancing, average daily trading activity in Athens remains thin, limiting the market’s ability to absorb large sell orders, analysts say.

In a market with limited depth, sharp moves by foreign leveraged funds inevitably act as a multiplier of instability. When international markets enter a correction, the withdrawal of capital from peripheral markets leads to a disproportionate widening of spreads and sharp swings.

The real challenge for the Greek market, however, is not the strength of the balance sheets of Greek listed companies, but the resilience of the domestic system in the face of a possible global deleveraging.

When liquidity is abruptly withdrawn around the world, even the healthiest economies must prove they can withstand the shock.