Minutes from the Federal Reserve’s (Fed’s) January discussions in setting monetary policy imply that some policy-makers may worry about equity valuations.
The Fed releases detailed minutes of its meetings about three weeks after the event. These minutes are something of a double-edged sword, they offer insight into the Fed’s latest thinking but inevitably draw on data that is several weeks old. However, these notes can yield insight’s into the direction the Fed is taking and how its position may evolve.
The January minutes were notable as some Fed policy-makers started to hint at elevated financial valuations, which have been less of a theme in prior meeting notes. For example, the January notes stated that. “The staff judged that asset valuation pressures had increased in recent months to an elevated level.” Furthermore, “Several participants observed that equity, corporate debt, and CRE valuations were elevated.”
The Fed worries about equity, and other, valuations, not because it is trying to time the markets, but because asset valuations can have a knock-on impact for the real economy. For example, the Fed states that. ”Financial imbalances—including overvaluation and excessive indebtedness— could amplify an adverse shock to the economy.”
Now, of course, the Fed isn’t saying anything revolutionary here. It has been clear for several years that on most traditional measures of valuation the U.S. markets are expensive relative to history and international comparison. The S&P 500 currently trades at a 24x PE when the historical norm is closer to 15x. Interestingly, even though low inflation and low interest rates may support this for now, many other global markets are far closer to their historical average valuation levels with similarly benign inflation and even lower interest rates. Still, it is interesting that U.S. valuations have perhaps reached a threshold where the Fed is starting to take note and maybe express concern.
However, the Fed’s mandate is primarily to keep inflation in check and sustain robust employment. Trying to keep the financial markets within a particular valuation range is a stretch for the Fed given its limited set of tools and because financial markets themselves are extremely complex. As such, it is unlikely the Fed will take action beyond words to tamp down potentially frothy stock valuations. Indeed, the Fed may do nothing. However, it will be interesting if 2020 marks the point where the Fed does offer more comment on the valuation of U.S. equity markets.
In addition, the Fed’s notes suggest that though some participants are concerned about valuations, it’s not a firm Fed view at this point. This theme is buried in the detailed meeting notes rather than coming anywhere near the executive summary. As such this theme has some way to go before it receives prime billing, if ever.
However, the Fed has spoken out before at both ends of equity market extremes. Former Fed Chair, Alan Greenspan’s comments on the stock market’s irrational exuberance received much attention, but came years before a bear market. At the other extreme, Fed Chairs have had supportive words at times of equity market weakness too.
Perhaps we will see the current Fed Chair Jerome Powell looking to weigh in on the the current U.S. bull market if the stocks prices continue to run up ahead of profits. The Fed has no real teeth to drive change on this issue, but words may still move the markets, even if temporarily.
This article originally appeared on Forbes.
