The bull run in the stock-market may soon come to an end, Martin Feldstein, the economist who chaired US president Ronald Reagan’s Council of Economic Advisers from 1982 to 1984, tells CNBC. “If it is not a bubble, it is very close” to one. Feldstein points out that “the S&P 500 price-earnings ratio is now more than 50% higher than it has been on average historically, so that’s way out of line and it makes the whole situation very fragile”.
Much of this can be laid at the feet of the US central bank, the Federal Reserve. “The federal funds rate, the rate the Fed controls directly, is less than 2% at a time when inflation expectations and actual inflation are both 2%.” As a result, the real (after-inflation) interest rate is negative, which tends to push asset prices higher. “The Fed should have started raising… rates a few years ago,” he notes. By not doing so, “they created this fragile situation in which asset prices are too high.”
But it’s not just about inflation – it’s also a question of the overall stability of the system, he says. The Fed focuses on commercial banks and whether they have enough capital, whereas “the real risk is in the fact that the stockmarket and commercial real estate are way out of line with the prices that they should be”.
If those snap, it could result in a downturn in markets and therefore in the economy. And if a recession was to occur, with rates as low as they are, the Fed currently “has no tools to offset that”, he tells Fox Business.