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Janet Yellen nails how investors should think about stock market valuations

Sam Ro
Managing Editor
Federal Reserve Chair Janet Yellen sheds light on how investors should think about stock market valuations. December 13, 2017. REUTERS/Jonathan Ernst

For some time, the Federal Reserve has been acknowledging that stock market valuations are high.  Fed Chair Janet Yellen reiterated this during a Q&A session at the end of the Federal Open Market Committee (FOMC) meeting on Wednesday.

“The stock market has gone up a great deal this year,” Yellen said. “And we have in recent months characterized the general level of asset valuations as elevated. What that reflects is simply the assessment that looking at price-earnings ratios and comparable metrics for other assets other than equities, we see ratios that are in the high end of historical ranges.”

But that’s not to say that investors should immediately dump stocks for fear of a correction. Yellen suggested as much in what may be the most perfect articulation of how investors should think about valuations.

The fact that those valuations are high doesn’t mean that they’re necessarily overvalued,” Yellen said.

For starters, high valuations don’t portend lackluster returns in the near term. History shows that valuations provide no reliable signal as to what will happen in the next 12 months.

In her explanation, Yellen also pointed to the current interest rate environment.

“We are in a … low interest rate environment. Lower than we’ve had in past decades,” she said. “That’s a factor that supports higher valuations.”

Billionaire Warren Buffett is among investing experts who have argued the same thing. “Everything in valuation gets back to interest rates,” Buffett said to Yahoo Finance’s Andy Serwer earlier this year.

In some ways, Yellen’s cool assessment of the stock market is the opposite of what then Fed Chair Alan Greenspan said in 1996 when he asked, “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions…”

To be clear, Yellen isn’t exactly saying stock prices will continue going up.  All she’s saying is that the fact that valuations are high doesn’t mean that they’re necessarily overvalued.

Sam Ro is managing editor at Yahoo Finance.

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