Some Fed Members Are Getting Worried About Stock Valuations. Here's What The Charts Show

  • Some Fed officials see equity prices as ‘quite high’
  • A range of metrics shows varying results on valuations

The Fed’s Communication Challenge on the Balance Sheet

How high is too high? Not for the first time, Federal Reserve officials have injected themselves into the debate on stock valuations, pointing out lofty U.S. equity markets in the minutes of their March gathering.

“Some participants viewed equity prices as quite high relative to standard valuation measures,” according to minutes of the discussions released Wednesday. “Some measures of valuations, such as price-to-earnings ratios, rose further above historical norms," the central bank noted.

While no Fed names were specified, Chair Janet Yellen has said before that equity valuations are quite high -- for example when she spoke in Washington in May 2015. The S&P 500 has rallied 13 percent since then, spurring observers including Robert Shiller to warn that the market is over-priced. Yet a wide array of metrics suggests the case isn’t a slam-dunk.

“Stocks might be a little bit above average in terms of their valuation in the U.S. but it’s not prohibitive to further advance,” said Jeffrey Kleintop, chief global investment strategist with Charles Schwab & Co., in an interview in Hong Kong. “Markets never really stop at average or a little bit above average on valuation. They tend to get very expensive before they pull back sharply in terms of a major recession or bear market. So I don’t think they’re that expensive.”

Kleintop compares U.S. equities with how technology stocks tend to have higher relative valuations than other sectors. The same can be said of comparisons between countries, he added. “It’s got the growth and tends to come with a pretty high price tag,” he said. “You look at the U.S. versus the rest of the world, the P/E between the U.S. and Japan naturally should be quite different.”

As the debate over expensive equities looks poised to heat up again, here are some charts that may help inform the discussion.

First, there’s what’s known as the Fed model, which compares the earnings yield for stocks with Treasury rates. This remains within historical ranges over the past decade, though above the levels when then-Fed Chair Alan Greenspan warned in 1996 of "irrational exuberance" in the stock market.

By comparing price-to-earnings multiples on both the S&P 500 and the MSCI World Index of global stocks, both equity gauges remain broadly in line with past trends, as the chart below shows.

It’s worth noting, given the above, that American equities have smashed returns on the global index since the start of this bull market in 2009, as the chart below shows.

One of the most closely watched valuations metrics is the CAPE ratio, popularized by Shiller, the renowned economist. His now commonly used measure is based on average inflation-adjusted earnings from the prior 10 years. As the chart shows, the gauge has surpassed levels seen during the 2008 Financial Crisis, while still well below the highs of the Dot-Com bubble at the turn of the century.

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