The major U.S. indices, including the S&P 500, have pulled back modestly after hitting highs in recent sessions. Markets appear to be consolidating, as investors digest recent gains. Fed Chair Powell’s remarks that equity valuations are “fairly highly valued” add caution.
While the market largely expects a rate cut in October, the Fed’s tone around future action remains cautious. Powell highlighted a slowing economy, cooling labour market, and inflation (core PCE at 2.3%) still above target, driven partly by tariff-related goods prices. He cautioned against aggressive rate cuts to avoid re-igniting inflation, with markets now pricing in just one more 25-basis-point cut this year (October or December).
My view is that demand for AI will boost the economy and the labour market, and when this becomes apparent the Fed won’t cut rates. The disappointment will trigger a stock market sell off because stocks are overvalued. The Warren Buffet indicator hit a record high of 220.8% this month, surpassing previous peaks like the dot-com bubble (150%) and the 2021 highs (200%). Historically, levels around 75-90% suggest fair value, while readings above 120% indicate overvaluation, and extremes near or above 200% signal “playing with fire” and potential for corrections. That’s why Powell is cautious about future cuts, Fed members want to see the data before committing to a rate cut. The stock market is forward looking, people will sell ahead of the news and I suspect the stock market will face severe headwinds.