Federal Reserve Governor Lisa Cook issued one of the most candid warnings from a Fed official regarding the stock market on Monday.

Cook stated, "Many asset classes, including stocks and CSI Enterprise bond Index, are highly valued, and the estimated risk premium is close to the bottom of its historical distribution, indicating that market pricing may be at a perfect level, making it susceptible to a significant drop due to unfavorable economic news or shifts in investor sentiment."

Fed Chairman Powell has rarely been so outspoken when discussing markets, and Cook's current comments inevitably recall former Chairman Alan Greenspan's warning about 'irrational exuberance' in 1996.

Unlike the immediate market turmoil triggered by Greenspan's remarks, Cook's comments were largely overlooked.$S&P 500 Index (.SPX.US)$On Monday, it recovered the 6000-point mark, approaching historical highs, then gave back some gains, but still closed up 0.6%.

The CMDI (Corporate Market Distress Index) compiled by the New York Fed is also at historical lows.

It is undeniable that stock market valuations are high by historical standards. The S&P 500 Index rose at least 20% for the second consecutive year last year. Goldman Sachs noted that the valuation of the S&P 500 Index (relative to its book value and sales) is two standard deviations above the average level of the past decade.

The cyclically adjusted PE ratio (CAPE) developed by economist Robert Shiller is about 37, nearing the highest level since the collapse of the Internet bubble. CAPE is divided by the inflation-adjusted real stock price and the average real EPS over the past decade, making it a powerful tool for assessing long-term stock market returns. Meanwhile, it is considered not very useful for timing market tops, as it has remained high for an extended period.

Although Greenspan's speech in December 1996 did trigger volatility in the global markets, it did not mark the end of the rebound driven by Internet companies, which peaked in early 2000. This may also explain why bullish investors seem indifferent to Cook's warning.

Greenspan 'was not wrong, but he warned four years early,' said Art Hogan, Chief Market Strategist at B. Riley Wealth, in a phone interview. 'Since then, officials seem to have been trying to avoid comments on valuations.'

He pointed out that meanwhile, among the 11 sectors of the S&P 500 Index, five sectors performed better than the Large Cap by the end of 2024, indicating that this round of rally has begun to spread from the so-called 'Magnificent Seven' technology stocks, which may help alleviate concerns about valuations.

At a time when US stock valuations are high, investor optimism about the prospects of AI continues to simmer, while they hope the second term of Trump’s administration will relax corporate regulations.

Almost all Wall Street strategists expect the stock market to continue rising. Even rare bearish Analysts on US Stocks, such as Barry Bannister from Stifel, stated that aside from valuations, some additional catalysts—such as economic deterioration—will be needed to correct the market.

Meanwhile, if fundamentals begin to deteriorate, high valuations could make the market vulnerable.

Kevin Simpson, CEO of Capital Wealth Planning, stated in a report on Monday: 'The fourth quarter Earnings Reports season will begin next week, and we expect performance to be the focus, as investors seek earnings growth to support current valuations and analyze how companies respond to the declining federal funds rate.'

He wrote: 'The market generally expects that EPS for the S&P 500 Index will grow nearly 15% in 2025, more than double the historical average. If the Earnings Reports season sends any dangerous signals, especially from large technology stocks, this will amplify concerns about valuations.'

Editor/Rocky