Yellen and Powell to Investors: Stocks Are Getting Pricey

The stock market  fell sharply on Tuesday, with most of the losses coming late in the session. Declines for the Nasdaq Composite (^IXIC 0.52%), S&P 500 (^GSPC 0.70%), and Dow Jones Industrial Average (^DJI 0.78%) weren't all that significant at around 1%, but some other measures of the market showed more substantial losses.

Data source: Yahoo! Finance.

Most investors focused on testimony by Treasury Secretary Janet Yellen and current Fed Chair Jerome Powell before the House Financial Services Committee. Their comments didn't incite a sudden flash crash, but they did give investors fair warning that they shouldn't expect the explosive gains that the market has given them over the past year to continue forever.

Image source: Getty Images.

What the past and current Fed chairs said

As a former Fed chair herself, Yellen can certainly understand the position that Powell is in now. Yet it's important to point out that as part of the current administration, Yellen's role leading the Treasury involves a different mission and a different set of guidelines. Specifically, the Biden administration is under no mandate to try to balance job creation with controlling inflationary pressures, and the Treasury Secretary, therefore, can espouse different fiscal policy strategies than you'd see the Fed chair supporting from the monetary policy side of the equation.

For the most part, though, Yellen and Powell said similar things. Yellen noted that with coronavirus vaccinations moving at an accelerating pace, there's reason to believe that the economy will recover sharply in the near future. Powell said that the Fed stands ready to continue supporting a full economic recovery, with the intent of holding off on any signs of tightening monetary policy until central bank officials have seen what he called "substantial further progress" toward returning to near-full employment and the 2% inflation target. Powell also said that investors could expect plenty of advance notice before the Fed would start to pull back on the asset purchases it has been making in the bond market.

Are stocks expensive?

Yet the thing that spooked stock market investors came from the views the two government officials expressed about valuations. Yellen admitted that the stock market is expensive compared to traditional measures of valuation. She didn't see that as an immediate problem, though, suggesting instead that as long as the financial industry has the strength to ensure that markets can function efficiently, there shouldn't be lasting problems. Yellen's implication is that even if markets were to fall, that wouldn't pose systemic threats unless big banks and other financial institutions have not maintained appropriate risk levels.

Powell echoed those sentiments, noting that some parts of the stock market are highly valued, but big banks have plenty of capital and show no obvious signs of lacking appropriate reserve levels to protect against future setbacks.

Big moves throughout the markets

The comments from Yellen and Powell had impacts well beyond the stock market. Bond prices surged, with yields on the 10-year Treasury falling significantly to reverse some of the big year-to-date climb they had seen.

In the oil markets, investors reacted both to the testimony and to news that European nations might be slower to reopen their economies than hoped. Extended lockdowns in Germany through the Easter holiday reflect the latest wave of COVID-19 cases, raising concerns that a delayed recovery in Europe could weaken energy demand. Crude prices plunged nearly $4 per barrel to drop below the $58 mark.

Investors will want to watch closely to see whether the stocks they own seem overvalued by traditional measures. Those investing for the long run shouldn't necessarily change their strategies, but being aware that greater volatility could be ahead will prepare you for whatever comes next. Having a plan for whatever happens will be crucial if things don't play out for the economy or the markets the way everyone hopes they will.