Warren Buffett's Favorite Market Gauge Just Hit Its Highest Level Since the 1999 Dot-Com Peak. History Says Investors Should Watch Valuations Closely.

Warren Buffett has spent decades telling everyday investors that their best bet is to put their money in the S&P 500 (SNPINDEX: ^GSPC) and simply give it time to grow. Don't spend hours and hours researching stocks with the hope of outperforming the market. Just buy the American economy and let long-term compounding growth do the rest.

But one of Buffett's favorite valuation measures is flashing a warning right now. This Rare Signal Is Flashing Again. In 2009, a "Double Down" signal flashed for a little-known chipmaker called Nvidia.

For the first time in years, that same "Total Conviction" signal is flashing for a company 1/100th the size of Nvidia. Continue » The Buffett indicator, which measures the total value of the U.S. stock market relative to the U.S. gross domestic product (GDP), recently hit 244%, its highest level ever, and well above the tech bubble peak of around 150%. In other words, investors are paying record-high prices for each unit of U.S. economic growth.

Buffett has said that investors are "playing with fire" whenever this indicator approaches 200%. Does this mean investors should be exiting the S&P 500 right now? The Buffett indicator makes intuitive sense.

Stock prices ultimately need to be supported by corporate earnings and a growing economy. But it's important to recognize that it's a valuation measure. It's not a buy/sell signal.

Let's imagine a scenario in which you took Buffett's "playing with fire" comment to heart and decided to sell your stake in the Vanguard S&P 500 ETF (NYSEMKT: VOO) when the Buffett indicator first hit 200%. That means you would have sold sometime in late 2021, near the end of the COVID-19 recovery. You would have avoided the 2022 bear market, which is good.