30.07.202510:48 Forex Analysis & Reviews: US equities: overbought territory or new normal?

While the US stock market pulls back from another all-time high, the Buffett indicator continues to set fresh records. To recap, Warren Buffett's indicator reflects the ratio of the US. stock market capitalization to GDP. It has now risen more than two standard deviations above the historical norm.

Typically, such a reading is interpreted by investors as a sign of market overvaluation and a potential correction ahead. However, it's important to remember that the Buffett indicator, like any other macroeconomic gauge, is not a definitive predictor of future market moves. It merely offers additional context for analysis.

It's crucial to understand that GDP is a backward-looking metric, reflecting past economic performance. The stock market, by contrast, is forward-looking, attempting to price in future corporate earnings and economic growth. As a result, discrepancies between the two can stem from investor expectations about the outlook.

Moreover, the market cap-to-GDP ratio is influenced by a wide array of factors, including interest rates, inflation, geopolitical conditions, and investor sentiment. Low interest rates, widely anticipated from the Fed, can support higher market capitalizations by making equities more attractive relative to bonds. Therefore, the Buffett indicator flashing "overbought" is far from a guarantee that the current bull cycle is nearing its end.

In the current environment, where the global economy continues to expand, albeit slightly slowed by Trump's tariffs, and central banks are still supporting liquidity, the stock market's overvaluation does not appear overly alarming. However, investors should remain vigilant and factor in the risk of a correction, especially amid rising inflation and potential monetary tightening.

It is also worth noting that the indicator has long exceeded the levels seen during the Dot-com bubble and the 2008 crisis. Similar readings were typically observed ahead of historical market crashes. Of course, historical analogies do not always repeat precisely. The structure of today's economy and financial markets is vastly different from what it was during the Dot-com era or prior to the 2008 financial crisis. For instance, the role of tech companies in shaping GDP and market capitalization is now significantly greater. Furthermore, globalization and the interconnectedness of financial markets mean that the Buffett indicator may no longer be an accurate reflection of the real state of the US economy.

That said, the current market condition could persist for a prolonged period, and equities may continue climbing, especially given that, sooner or later, the Fed is expected to begin cutting interest rates from the current 4.5% level.

As for the technical setup on the S&P 500, the key task for buyers today will be to overcome the nearest resistance level of $6,385. A breakout would support further growth and open the door for a move toward $6,392. Another top priority for bulls will be gaining control over the $6,400 level, which would reinforce buyer positions. If the market moves lower on fading risk appetite, buyers will need to defend the $6,373 zone. A breakout of this level would quickly drag the instrument back to $6,364 and potentially pave the way to $6,355.