Get out of stocks when they are overvalued, especially when P/E multiples eclipse earnings.
That’s just common sense, but it makes more sense if stocks are overvalued and a recession is lurking over the horizon. Stocks may be overvalued, but it’s hard to discern a recession in the foreseeable future. It isn’t hard seeing earnings continue to rise in record territory. So any sell-off is more likely to be yet another panic-attack correction rather than the beginning of a bear market.
The S&P 500 dropped sharply, by 1.5%, on Thursday last week. The financial press blamed the latest brouhaha in the White House for the selloff. Melissa and I think it had more to do with the July 25-26 FOMC minutes released on Wednesday. Fed officials are suddenly focusing on “financial stability.”
The phrase appeared just four times in the minutes of the June 13-14 FOMC meeting. It appeared eight times in the latest minutes, with a lengthier discussion of this topic than in the recent past. Perhaps Fed officials are all getting excited about going to their annual conclave at Jackson Hole this week, from Thursday through Saturday. The topic this year is “Fostering a Dynamic Global Economy.” Fed Chair Janet Yellen, who might be singing her swan song, is scheduled to speak on Friday and focus on, you guessed it, financial stability.
During their meeting in late July, the FOMC participants did something they rarely do—they “considered equity valuations in their discussion of financial stability.” Such attention by the Fed should make stock investors nervous. However, the discussion must have been fairly brief and benign. This was the gist of what was said on this subject per the minutes:
(1) “According to another view, recent rises in equity prices might be part of a broad-based adjustment of asset prices to changes in longer-term financial conditions, importantly including a lower neutral real interest rate, and, therefore, the recent equity price increases might not provide much additional impetus to aggregate spending on goods and services.”
(2) “A couple of participants noted that favorable macroeconomic factors provided backing for current equity valuations; in addition, as recent equity price increases did not seem to stem importantly from greater use of leverage by investors, these increases might not pose appreciable risks to financial stability.”
That’s not very threatening to the bull market. There was more concern expressed about a potential jump in bond yields: “A number of participants pointed to potential concerns about low longer term interest rates, including the possibility that inflation expectations were too low, that yields could rise abruptly, or that low yields were inducing investors to take on excessive risk in a search for higher returns.”
It sure doesn’t sound like the Fed is about to tighten monetary policy for the sake of restoring financial stability in the stock market, i.e., to push valuations lower. Quite the opposite, the minutes suggested that Fed officials remain puzzled by how low inflation remains, presumably giving some of them second thoughts about raising interest rates again anytime soon.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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