As the Federal Reserve kicks off a long-awaited rate cutting cycle, some investors are wary that richly valued U.S. stocks may have already priced in the benefits of easier monetary policy, making it harder for markets to rise much further.
But stock valuations have climbed in recent months, as investors anticipating Fed cuts piled in to equities and other assets seen as benefiting from looser monetary policy. That has left the S&P 500 trading at over 21 times forward earnings, well above its long-term average of 15.7 times. The index has climbed 20% this year, even as U.S. employment growth has been weaker than expected in recent months.
A drop in rates also reduces yields on cash and fixed income, diminishing them as investment competition to equities. The yield on the benchmark 10-year Treasury has dropped about a full percentage point since April, to 3.7%, although it has ticked up this week. Valuations in the technology sector have also overshot their long-term averages, thanks to massive rallies in stocks such as Nvidia, which is up around 140% this year. The tech sector trades at about 28 times earnings, compared to a long-term average of 21, according to LSEG Datastream.
“You could argue that some of a potential ‘no recession easing cycle’ gains have been borrowed from the future this time,” Reid said in the note.