As said this morning, the Fed hedged dovish minutes today with this:
This overall assessment incorporated the staff’s judgment that, since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets.
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.
According to one view, the easing of financial conditions meant that the economic effects of the Committee’s actions in gradually removing policy accommodation had been largely offset by other factors influencing financial markets, and that a tighter monetary policy than otherwise was warranted.
I don’t call US stocks a bubble at this point for one simple reason. If you accept that interest rates are stuck in lowflation more or less permanently then the lower “rick free rate” justifies paying more for yield. Capital Economics has more:
• The 12-month forward earnings/price ratio of the S&P 500 remains much higher than the nominal yield of 10-year Treasuries. The equity yield is now around 5.6%, whereas the bond yield is only about 2.3% (1). Corporate earnings are affected by inflation. But even if the equity yield is compared with the real yield of 10-year TIPS, the equity yield still appears comparatively high (2). The risk premium of US equities appears higher than that of US corporate bonds, unlike during the dot com bubble (3).
• The bears argue that the stock market is overvalued because the equity yield is low by the standards of the past. But the equilibrium level of the equity yield is a function of the equilibrium levels of investors’ required real return from “risk-free” assets and the equity risk premium, which have fallen in our view. So we do not think it makes sense to assume that the equity yield will inevitably revert to its long-run average. In our opinion, the equilibrium level of the equity yield now is probably about 4.5%, which is equivalent to a price/earnings ratio of 22.2 (4 & 5).
• Meanwhile, despite concerns about high share prices in the US technology sector, its valuation does not appears to be stretched relative to that of the broader market, unlike during the dot com bubble (6).
At some point the Fed will tighten further and pull this thing down but it needs the cover of at least decent inflation to do it.
I don’t see any existential risk to the lowflation paradigm for now. Perhaps next year when the oil market genuinely tightens or US wage growth finds more traction.