The Federal Reserve issues a rare direct warning to U.S. stocks, with board member Cook stating that the market's valuation is too high and could face a significant correction.

Federal Reserve Governor Lisa Cook issued a rare direct warning to the stock market on Monday. Cook said, "Valuations of multiple asset classes, including stocks and corporate bonds, are high, with risk premium valuations close to historical lows, suggesting that the market may be priced to perfection. Therefore, these markets may face significant downside risks from adverse economic news or shifts in investor sentiment." Federal Reserve Chairman Powell rarely speaks so bluntly about the market, and Cook's comments are reminiscent of former Federal Reserve Chairman Alan Greenspan's warning of "irrational exuberance" in 1996. However, unlike Greenspan's remarks that caused market volatility at the time, Cook's warning has not been taken seriously by the market. The S&P 500 index crossed the 6000 mark on Monday and is nearing historic highs. According to the New York Fed's Corporate Bond Market Distress Index, distress levels in the corporate bond market are also at historically low levels. The S&P 500 index has risen over 20% in the past two years, and from a historical perspective, it is undeniable that market valuations are high. According to Goldman Sachs data, the valuation of the S&P 500 index is two standard deviations above the 10-year average relative to book value and sales. The cyclically adjusted price-to-earnings ratio developed by economist Robert Shiller is around 37, close to the highest level since the bursting of the dot-com bubble. The CAPE ratio provides a long-term perspective by comparing the price of the S&P 500 index to the average corporate earnings over the past ten years to measure whether market valuations are at reasonable levels. However, CAPE has limited utility in predicting market tops, as it has historically remained high. Although Greenspan's warning in 1996 caused short-term market turbulence, it did not end the bull market driven by the dot-com bubble, which peaked in early 2000. This may explain why investors are reacting indifferently to Cook's warning. "Greenspan wasn't wrong, he was just four years early," said Art Hogan, Chief Market Strategist at B. Riley Wealth. "Since then, Fed officials seem to have tried to avoid commenting on market valuations." Despite high valuations, five out of 11 sectors in the S&P 500 outperformed the index in 2024, showing that the market is gradually expanding beyond the mega-cap tech stocks represented by the "Fab Seven." Hogan believes this trend helps alleviate valuation concerns. Currently, investors' optimism is partially driven by the development of artificial intelligence and expectations for deregulation policies that the second Trump administration may implement. Despite concerns about high valuations, almost all Wall Street strategists predict that the stock market will continue to rise. Even a few bearish analysts, such as Barry Bannister of Stifel, believe that a market correction would require deterioration in economic fundamentals, not just high valuations. At the same time, excessive valuations may make the market more vulnerable to shocks when fundamentals deteriorate. Kevin Simpson, CEO of Capital Wealth Planning, pointed out in a report on Monday, "The fourth-quarter earnings season will kick off next week, and investors will be watching whether earnings growth can support current valuation levels and analyzing how companies are responding to the decline in federal fund rates." Simpson added, "The market consensus expects earnings per share growth of close to 15% for 2025, more than double the historical average level. If the earnings season raises concerns about expectations, especially for mega-cap tech stocks, it will exacerbate fears of high valuations."