From Greenspan’s “irrational exuberance” to Powell’s “U.S. stock valuations are high,” what does the Federal Reserve Chair’s “risk warning” mean for the markets?

From Greenspan’s “irrational exuberance” to Powell’s “U.S. stock valuations are high,” what does the Federal Reserve Chair’s “risk warning” mean for the markets?

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The warnings from Federal Reserve chairs about stock market valuations have always attracted much attention from the market, but according to the latest research by J.P. Morgan, such warnings often have limited actual impact on the market.

This week, Powell explicitly stated in his speech that while stock prices are "fairly high in valuation," this is not a period of elevated financial stability risks. He emphasized that the path of further policy normalization is not without risks. This statement continues the tradition of Fed chairs issuing warnings on asset price valuations.

According to Following the Wind Trading Desk, J.P. Morgan's analysis shows that from Greenspan's "irrational exuberance" in 1996 to Powell's claim this week that stock prices are "fairly high in valuation," concerns from Fed chairs over valuations have not triggered significant market corrections.

According to J.P. Morgan, after each valuation warning by Fed chairs since 1996, the S&P 500 index has not recorded negative returns in the subsequent 1 month, 6 months, or 12 months. On average, the positive returns in the 12 months after a warning were only slightly lower than those in the 6 months before the warning, indicating the market growth slowed but still maintained an upward trend.

Historical Fed Chair Valuation Warnings

J.P. Morgan has compiled all the Fed chair valuation warnings since Greenspan's warning of "irrational exuberance inappropriately boosting asset values" in December 1996. These warnings covered different macroeconomic environments, but most occurred during periods of loose monetary policy.

Bernanke warned of excessive risk-taking in May 2013; Yellen expressed concerns about high valuations in specific sectors and the overall market in July 2014 and May 2015, respectively. Powell discussed valuation issues in relative terms during the pandemic and attributed asset price bubbles in April 2021 to the impact of vaccination and economic reopening.

According to J.P. Morgan's statistics, in the 6 months before these warnings, the market rose on average about 14%, with the range from 2% in May 2015 to more than 24% in May 2021.

Market Reaction Patterns: Limited Warning Effect

J.P. Morgan's research reveals three key observations.

First, Fed chair valuation warnings did not trigger negative stock returns in the subsequent 1 month, 6 months, or 12 months. The immediate impact was fairly mild; within one month, the S&P 500 saw a slight positive return, and international stock markets were flat to slightly negative.

Second, the average positive return in the 12 months following a warning was slightly weaker than that in the 6 months preceding the warning, indicating market growth slowed but remained resilient.

After excluding the internet bubble and pandemic period, the U.S. stock market usually outperformed international markets after the warning. There were exceptions, such as after the 2013 and 2014 warnings, when the German stock market outperformed U.S. equities due to expectations of low interest rates and quantitative easing.

Third, broad valuation assessments are often based on historical data, which can obscure the effects of structural changes such as shifts in industry composition and technological breakthroughs like artificial intelligence. The 12-month forward P/E ratio basically stayed stable after the warnings, indicating that stock market performance was mainly driven by improved earnings rather than valuation expansion.

Compared to High Valuations and Concentration, Macro Weakness is More Likely a Market Correction Catalyst

Although high valuations and extreme market concentration have prompted comparisons between today’s market and the late 1990s tech bubble, there are significant differences between the two periods.

J.P. Morgan emphasizes that the valuations of current growth stocks are built on solid fundamentals. Unlike during the tech bubble, which relied on "hockey stick" profit forecasts and market mania, today’s leading growth companies are achieving robust double-digit organic growth, have solid profit margins of about 25%, and are returning capital to shareholders through buybacks and other means.

The report states that the "quality" and "growth" characteristics are the key pillars supporting current valuations. Therefore, although high valuations and crowded trades may suggest market fragility, valuation alone is unlikely to be a direct catalyst for a market pullback.

J.P. Morgan believes that for investors, it is better to focus more on macroeconomic fundamentals than on valuation levels. High valuations themselves are not a trigger, but they do reduce the market's resilience in the face of shocks. A significant market pullback is more likely to be triggered by macroeconomic weakness, such as labor market deterioration.

Additionally, the analysis points out that traditional valuation assessments are often based on historical data, which may obscure changes in economic structure, such as shifts in industry composition and the impact of structural breakthroughs like artificial intelligence (AI). These new factors could reshape the logic behind market valuations.

Looking ahead to 2026, J.P. Morgan expects the market to rebound. Supporting factors include the expansion of the AI investment cycle, strong capital expenditure activity, accommodative monetary policy, and robust balance sheets for households and corporate sectors.

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Risk Warning and DisclaimerThe market has risks, and investments need to be cautious. This article does not constitute personal investment advice, nor does it take into account the special investment objectives, financial situation or needs of individual users. Users should consider whether any opinions, viewpoints, or conclusions in this article are suitable for their particular situation. Investment based on this is at your own risk. ```