Equity market valuations are “quite high”

Central bankers have not covered themselves in glory in the past when timing turning points in financial markets and real estate, and hence when they should take away the punch bowl. Still, when they speak on market valuation, their comments can often unnerve investors. Such was the case on Wednesday when US Federal Reserve Chairwoman Janet Yellen, in a public conversation with IMF Director Christine Lagarde, remarked that “equity market valuations at this point generally are quite high”. In July 2014, Yellen warned about valuations in the biotech sector; the iShares NASDAQ Biotech ETF has since risen by around 30%.

So how high is “quite high”? Well according to Janet, “they are not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there”. In other words, compared to cash and short term government bonds equities look attractive and the risk is what happens when the Fed raises rates.

Of course, this conundrum is a manifestation of their exceptionally loose monetary policy over the last six years. The responsibility now falls with the Fed and other central banks to somehow prevent these “potential dangers” from coming to fruition. Let’s hope they prove to be better at normalising monetary policy than their record on stock market predictions.