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What Happens When the Fed Warns the Market Is Overvalued

Thursday, April 6, 2017 10:42
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(Before It's News)

While investors hang on every dovish word bluffed from a venerable Fed speaker’s mouth, the cognitive dissonance when something negative is uttered is stunning. Since Greenspan’s “irrational exuberance” moment, asset-gatherers and commission-takers have advised ignoring Fedspeak on stocks… historically, that was a mistake for investors.

Having shocked a soaring market yesterday with the Minutes stating:

“Broad U.S. equity price indexes increased over the intermeeting period, and some measures of valuations, such as price-to-earnings ratios, rose further above historical norms. … Some participants viewed equity prices as quite high relative to standard valuation measures.”

Of course, business media was quick to assert this is nothing to worry about, however, as CNBC’s Mike Santoli reports, traders shouldn’t be so quick to dismiss these comments from Fed officials.

History shows when worries about valuation appear in these official minutes, stocks often struggle in the following year.

We found six mentions of an overvalued stock market in the minutes by searching the Fed’s website for the word “valuation” going back to 1996. According to Kensho, here’s the performance of the major market averages one year after the meeting when such a mention took place.


Here are the specific mentions of high “valuation” in the minutes, according to the Fed’s website, along with the S&P 500′s subsequent return from the meeting when that mention was made.

Meeting: April 28-29 — 2015 S&P 500 return 1-year later: -1.97%

“However, some indicators suggested that valuations remained stretched for some asset classes. An estimate of the expected real return on equities moved down, reflecting an increase in stock prices and downward revisions to forecasts of corporate earnings, and corporate bond spreads declined somewhat.”

Sept. 16-17, 2014 — S&P 500 return 1-year later: -0.57%

“Some financial developments that could undermine financial stability over time were noted, including a deterioration in leveraged lending standards, stretched stock market valuations, and compressed risk spreads.”

Jan. 27-28, 2004 — S&P 500 return 1-year later: +3.8%

“A number of members commented that expectations of sustained policy accommodation appeared to have contributed to valuations in financial markets that left little room for downside risks, and the change in wording might prompt those markets to adjust more appropriately to changing economic circumstances in the future.”

Dec. 11, 2001 — S&P 500 return 1-year later: -20.39%

“Among those risks, members cited the apparently reduced prospects for additional fiscal stimulus legislation, the vulnerability of current stock market valuations should forecasts of a robust rebound in earnings fail to materialize, the possibility of further terrorist incidents, and especially the potentially adverse effect on consumer confidence and spending of additional deterioration in labor market conditions.”

March 21, 2000 — S&P 500 return 1-year later: -24.88%

“The divergence, at least until recently, in the stock market between the valuations of high-tech firms and those of more traditional, established firms was inducing a redirection of investment funds to business activities that were perceived to be more productive. While the associated capital investments undoubtedly had contributed to the acceleration in productivity, some members expressed concern that the historically elevated valuations of many high-tech stocks were subject to a sizable market adjustment at some point. That risk was underscored by the increased volatility of the stock market.”

Dec. 17, 1996 — S&P 500 return 1-year later: 32.99%

“The rise over recent years had been extraordinary and had brought market valuations to fairly high levels relative to earnings and dividends. In these circumstances, the members recognized the need to monitor with special care price movements in the stock market and asset markets more generally for their implications for consumer and other spending.”

Of course, it’s different this time though and markets can only go up… because Trump tax reform… stimulus… earnings… right?


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