Rare! Federal Reserve officials directly comment on the market: valuations are too high, and a significant decline is likely

Former Federal Reserve Chairman Alan Greenspan warned of "irrational exuberance" in 1996, and now Federal Reserve Governor Lisa Cook has stepped forward to warn that "U.S. stock valuations are too high." Direct warnings from Federal Reserve officials about market risks are quite rare.

According to MarketWatch, on Monday, Federal Reserve Governor Lisa Cook issued a rare direct warning about the stock market. She stated:

Valuations across multiple asset classes are elevated, including the stock and corporate bond markets, and these markets' risk premiums are expected to be close to the bottom of historical distributions. This means the market may be priced to perfection, making it vulnerable to significant declines that could be triggered by bad economic news or shifts in investor sentiment.

This statement recalls the "irrational exuberance" warning made by former Federal Reserve Chairman Greenspan in 1996, but unlike Greenspan's remarks, which had an immediate impact on the stock market, Cook's warning seems to have been ignored by the market. The S&P 500 index regained 6,000 points that day, nearing its historical high, and although the gains narrowed afterward, it still closed up 0.6%.

It is undeniable that, by historical standards, market valuations are indeed at historically high levels based on multiple indicators:

1. According to Goldman Sachs, the ratio of the S&P 500 index to its book value and sales is two standard deviations above the average level of the past 10 years.

2. Economist Robert Shiller's cyclically adjusted price-to-earnings (CAPE) ratio is about 37, close to the highest level since the burst of the internet bubble.

3. The S&P 500 index achieved at least a 20% increase for the second consecutive year last year.

However, high valuations do not necessarily mean the market is about to crash. Just as Greenspan's warning came four years before the peak of the internet bubble, high valuation conditions can persist for quite a long time.

Art Hogan, Chief Market Strategist at B. Riley Wealth, stated:

Greenspan was not wrong, but he made that call four years too early, and since then officials seem to have been trying to avoid commenting on valuations.

Meanwhile, five of the 11 sectors of the S&P 500 are expected to outperform the index by the end of 2024, indicating that the rally has begun to broaden beyond the seven tech giants, which, if true, could help alleviate valuation concerns.

Almost every Wall Street strategist expects the stock market to rise. Even the few analysts who expect the market to decline, such as Barry Bannister from Stifel, indicate that other factors (such as economic deterioration) are needed in addition to valuations for the market to pull back.

At the same time, if the fundamentals begin to deteriorate, excessive valuations could make the market vulnerable.

Kevin Simpson, CEO of Capital Wealth Planning, stated in a report on Monday:

The fourth quarter earnings season will begin next week, and we expect earnings to be the focus as investors seek earnings growth to support current valuations and analyze how companies respond to the Federal Reserve's interest rate cuts.

The market generally expects an earnings per share growth rate of nearly 15% in 2025, which is more than double the historical average. If the earnings season has any impact on expectations, especially from large technology companies, it will intensify concerns about valuations.

Risk Warning and Disclaimer

The market has risks, and investment should be cautious. This article does not constitute personal investment advice and does not take into account the specific investment objectives, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investing based on this is at one's own risk