Fed official delivers a blunt message to the stock market — which ignores it
Federal Reserve Governor Lisa Cook on Monday gave one of the bluntest warnings an official at the central bank has ever delivered about the stock market.
“Valuations are elevated in a number of asset classes, including equity and corporate debt markets, where estimated risk premia are near the bottom of their historical distributions, suggesting that markets may be priced to perfection and, therefore, susceptible to large declines, which could result from bad economic news or a change in investor sentiment,” Cook said.
Fed Chair Jerome Powell has rarely been that blunt in discussing the market, and Cook’s remarks were reminiscent of former Chair Alan Greenspan’s 1996 warning of “irrational exuberance.”
Unlike Greenspan’s remarks, which immediately affected the stock market, Cook’s remarks were largely ignored. The S&P 500 SPX recaptured the 6,000 level as it neared record highs on Monday. Stocks later trimmed gains, but the S&P 500 still ended with a gain of 0.6%.
The New York Fed’s corporate-bond-market distress index similarly was at a historically low level.
That stock-market valuations are high by historical standards is undeniable. The S&P 500 last year registered its second straight gain of at least 20%. According to Goldman Sachs, the S&P 500 — relative to its book value and to its sales — is two standard deviations above the average of the last 10 years.
Economist Robert Shiller’s cyclically adjusted price-to-equity ratio is around 37, which is near the highest level since the dot-com bubble burst. The CAPE ratio, as it is widely known, measures the price of the S&P 500 divided by average corporate earnings over the previous decade. By taking such a long view, its proponents argue that it smooths out cyclical variations and gives a better view of where valuations stand versus history.
At the same time, it’s not seen as very useful for timing market tops, having remained at lofty levels for extended periods in the past.
And while Greenspan’s December 1996 speech did indeed cause global markets to wobble, it hardly marked the end of a dot-com-fueled rally that didn’t top out until early 2000. That may also explain why bullish investors appeared to pay little heed to Cook’s warning.
Greenspan “wasn’t wrong but he was four years early in making that call,” said Art Hogan, chief market strategist at B. Riley Wealth, in a phone interview. “It seems from that point forward, officials have tried to stay away from valuation commentary.”
Meanwhile, five of the S&P 500’s 11 sectors ended 2024 outperforming the broader index, offering evidence that the rally has started to broaden out from the so-called Magnificent Seven megacap tech stocks, which, if so, could help alleviate valuation worries, he said.
Stretched valuations come as investors react to developments in artificial intelligence amid hopes for deregulation under a second Trump administration.
Still, virtually every Wall Street strategist expects the stock market to rise. Even the rare analyst who expects the market to fall , like Stifel’s Barry Bannister, says it would take something besides valuation — such as a deterioration in the economy — for the market to correct.
At the same time, lofty valuations could leave the market vulnerable if fundamentals begin to sour.
“Fourth-quarter earnings season will start next week, and we expect [earnings] to be front and center as investors look for earnings growth to support present valuations and to analyze how companies are reacting to a declining federal-funds rate,” said Kevin Simpson, chief executive officer of Capital Wealth Planning, in a Monday note.
“Consensus for 2025 EPS growth is close to 15% — which is more than double the historical average. If earnings season offers any red flags on expectations, especially from megacap tech names, it’ll amplify the concern on valuations,” he wrote.
William Watts contributed.
