Record Stock Valuations, Fed Independence, and Macro Volatility

By Bill Hester – Hussman Funds

Central bank independence can sound like an ivory tower debate topic – something economists argue about, far removed from the markets investors navigate every day. But at today’s elevated stock market valuations, it matters more than many realize. When central bank independence weakens, the risks don’t stay theoretical: inflation volatility tends to rise, recession risk can increase, and equity valuations can come under pressure.

As political pressure on the Federal Reserve intensifies and markets ponder the nomination of a new Chair, understanding this chain of risk is increasingly important for investors. Equity valuations are heavily affected by expectations for long-term cash flows, along with the interest rates and risk-premiums that drive how much investors are willing to pay for those future dollars. That means structural risks like potentially diminished Federal Reserve independence deserve close attention, because their effects would be felt over years, not just quarters. As Chair Powell noted in his latest press conference, once confidence in central bank independence is lost, it is extremely difficult to restore.