Could the US stock market collapse? Here’s what the Warren Buffett indicator says

Even with richly priced US tech stocks getting sold off earlier this month, the Warren Buffett indicator remains alarmingly high at 220.1%. That’s even more elevated than the peak of 2021, prior to the severe US stock market correction of 2022. And it signals that some serious trouble could be brewing.

So, should investors be worried? And if so, what is the best investing strategy right now?

Inspecting the numbers

As a quick reminder, the Warren Buffett indicator compares the total market capitalisation of the stock market against GDP. It’s a quick and easy metric to gauge how stock valuations are stacking up against tangible economic activity.

For most of the last decade, this indicator sat between 110% and 150%, signalling fair to moderately overvalued stock prices. It’s only been in recent years that valuations have started getting really stretched. And it would explain why Buffett’s Berkshire Hathaway has been far more cautious lately.

This means investors are currently attaching a lot of value to the future cash flows of businesses. And that significantly increases the risk of short-term volatility, especially if sentiment shifts and businesses start missing earnings targets. And it explains why several institutional investors are warning of a potential market correction or even a full-blown crash in 2026.

The team at Capital Economics has explicitly warned that the S&P 500 could experience a double-digit decline, with similar projections coming from Goldman Sachs if earnings fail to keep up with expectations.

So, where does that leave investors today?

Investing like Buffett

When valuations are running hot, Warren Buffett starts hoarding cash. Apart from being a solid hedge against short-term volatility, this move also ensures he’s got a big pile of capital to take advantage of new buying opportunities when the stock market eventually takes a tumble.

However, it’s also worth pointing out that even in 2026, there remain plenty of S&P 500 stocks trading at pretty cheap valuations.

For example, having dropped by over 35% in the last 12 months, Trex (NYSE:TREX) shares are now trading at a price-to-earnings ratio of 23. While that’s high by UK standards, it’s significantly lower than the group’s long-term historical average of 33.

The composite wood decking business has been navigating through quite a tough market environment. Much like here in the UK, higher interest rates have placed significant downward pressure on demand for home renovation and improvement projects. And the impact on its financials has been pretty severe.

Inventory de-stocking headwinds combined with pressure on profit margins resulted in earnings targets being missed and the shares getting hammered in 2025. But as Buffett has said numerous times, the time to be greedy is when everyone else is fearful.

Despite its current challenges, Trex remains the global leader within the composite decking space. And with more interest rate cuts expected over the next 12 months alongside vendor inventory depletion, the business could be well-positioned for a recovery rally.

All eyes will be on its upcoming earnings report. If the company starts showing early signs of a rebound, then Trex shares could prove to be an attractive investment, even in today’s stock market climate. That’s why it’s a business I think investors should watch closely. And it’s not the only stock I’ve got my eye on.

The post Could the US stock market collapse? Here’s what the Warren Buffett indicator says appeared first on The Motley Fool UK.

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Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended Trex. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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