‘Buffett Indicator’ Flashes Warning on Japan’s Stock-Price Gains

One of Warren Buffett’s favorite gauges for valuing share prices is flashing warning signals for Japan after data showing that the world’s third-largest economy shrank in the second quarter while the stock market kept rising.

Japan’s gross domestic product report this week makes for sobering reading, with the economy contracting an annualized 1.6 percent in the second quarter as consumers cut back purchases, businesses trimmed spending, and exports declined. Yet, the broader Topix index reached to the highest level since 2007 this month.

The market capitalization-to-GDP ratio favored by Buffett reached 117 percent for stocks on the first section of the Tokyo Stock Exchange in the three months through June, the third-straight quarter above 100 percent.

Yasunari Ueno, chief market economist at Mizuho Securities Co. in Tokyo, said this points to a “bubble” in Japanese share prices.

There is a disconnect at work in Japan between share prices -- which measured by the Topix have doubled since Prime Minister Shinzo Abe came to power in December 2012 -- and the economy, according to Ueno.

That’s not to say the rally will end soon. The Topix remains more than 40 percent lower than its peak in 1989, and the Japanese benchmark is still cheaper than the Standard & Poor’s 500 Index when measured by price to estimated earnings.

Mizuho’s Ueno said Japanese stocks have been driven by the Bank of Japan’s monetary expansion, including its purchases of exchange-traded funds, along with public pension funds boosting their holdings of shares.

“Given the fact that private consumption declined considerably, regardless of the gains in shares, the government’s stock-boosting strategy is failing” to revive the wider economy, he said.