Federal Reserve Governor Lisa Cook delivered one of the most direct warnings from the central bank in recent memory regarding stock market risks. Speaking on Monday, Cook noted that “valuations are elevated in a number of asset classes, including equity and corporate debt markets, where estimated risk premia are near the bottom of their historical distributions.”
She cautioned that this situation indicates markets may be “priced to perfection” and therefore vulnerable to significant declines triggered by adverse economic developments or shifts in investor sentiment.
Cook’s remarks echoed the famous 1996 warning from former Fed Chair Alan Greenspan about “irrational exuberance,” a term that became synonymous with speculative excess. However, unlike Greenspan’s comments, which sent immediate ripples through global markets, Cook’s caution appeared to have little immediate impact. The S&P 500 briefly climbed past the 6,000 mark and closed the session with a 0.6% gain, even as it trimmed some of its earlier advances.
Metrics like the New York Fed’s corporate-bond-market distress index also signal a lack of current market stress, standing at historically low levels. Yet, concerns about elevated valuations persist. The S&P 500 has posted back-to-back annual gains of at least 20%, and its valuation metrics—such as price-to-book and price-to-sales ratios—are two standard deviations above the 10-year average, according to Goldman Sachs. Economist Robert Shiller’s cyclically adjusted price-to-earnings (CAPE) ratio hovers around 37, near levels last seen during the dot-com bubble.
While such indicators highlight overvaluation, they offer little guidance on timing market corrections. The CAPE ratio, for instance, has remained elevated for extended periods without precipitating market downturns. Similarly, Greenspan’s 1996 warning didn’t halt the dot-com rally, which peaked years later in 2000. This historical context may explain why bullish investors have largely brushed off Cook’s remarks.
“Greenspan wasn’t wrong, but he was about four years early,” said Art Hogan, chief market strategist at B. Riley Wealth. “Since then, Fed officials have generally steered clear of commenting directly on valuations.”
Despite concerns, market sentiment remains optimistic. Five of the S&P 500’s 11 sectors outperformed the broader index in 2024, suggesting the rally may be broadening beyond the “Magnificent Seven” mega-cap tech stocks. If this diversification continues, it could help temper valuation worries.
The optimism is fueled in part by advancements in artificial intelligence and expectations of deregulation under a potential second Trump administration. Still, lofty valuations leave the market exposed to risks, particularly if economic fundamentals deteriorate.
Kevin Simpson, CEO of Capital Wealth Planning, pointed to the upcoming fourth-quarter earnings season as a potential test for market resilience. “Consensus for 2025 EPS growth is close to 15% — more than double the historical average,” Simpson wrote in a Monday note. “If earnings disappoint, especially from mega-cap tech names, it could amplify concerns about valuations.”
As Wall Street strategists largely predict continued market gains, even bearish analysts like Stifel’s Barry Bannister acknowledge that valuations alone may not prompt a correction. Instead, it would likely take a broader economic downturn or unforeseen shocks to disrupt the current rally.
