Rich Valuations Get Richer as Yellen's Words Fall on Deaf Ears

  • U.S. stocks rally one day after the Fed chair says P/Es high
  • Through six months, S&P 500’s gain matches all of 2016’s

Why Markets Are Taking Hawkish Central Banks in Stride

Investors weren’t about to let Janet Yellen’s comments about equity valuations get in the way of a good bull market.

One day after the Federal Reserve chair and two of her colleagues said asset prices look rich, the S&P 500 Index staged its biggest rally in two months. True, the advance only reversed the previous day’s decline. But it was enough to dash the hopes of bears who had been salivating after technology stocks slipped below a key chart level.

The reaction highlights the futility of trying to get anyone to care about valuations after nine years of central bank stimulus helped share prices triple. Fed officials have periodically cautioned investors about elevated prices over the last three years. Never has the impact lasted more than a day or two.

“Yellen didn’t tell us anything that we didn’t already know,” said Dan Suzuki, senior equity analyst at Bank of America Corp. “The market is trading at elevated valuations and on pretty much every valuation metric there is. Unless she hints that the Fed plans to tighten more aggressively in order to curb the enthusiasm, I don’t think her comments on valuations are going to carry much weight.”

Helped when European Central Bank officials said markets had misinterpreted as hawkish comments from Mario Draghi, the S&P 500 rose 0.9 percent to 2,440,60 Wednesday, the biggest gain since April 24, while the Nasdaq 100 jumped 1.4 percent to 5,753.03. Based on annual earnings, the Nasdaq gauge trades for 26.1 times profits, roughly 30 percent higher than the average throughout the bull market.

Multiples briefly contracted Tuesday as the tech index slipped below its 50-day moving average on for the first time in seven months. While Yellen wasn’t the only reason, her comments that “asset valuations are somewhat rich” added to the bearish tone.

It wasn’t the first time a central bank official had made such observations. In May 2015, Yellen said stock valuations are “quite high” and could spur financial instability. The S&P 500 finished that week higher and rose the next two. In a report on monetary policy delivered to Congress in July 2014, officials said prices for smaller biotechnology and social media stocks were stretched. Equities also climbed that week.

One key difference today is a stronger backdrop for corporate earnings. S&P 500 companies posted the fastest profit growth since 2014 in the first quarter, and analysts expect revenue to climb in every industry group next year, according to Bloomberg.

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