Stocks Are Trading at Their Second-Priciest Level in 145 Years. The Fed Voted 12-0 to Keep Raising Rates Anyway.

The S&P 500 closed Monday at 7,807.24, basically flat on the day. Three trading days earlier, the index's most-watched valuation gauge told a louder story. The Shiller cyclically-adjusted price-to-earnings ratio, known as CAPE, closed at 41.87 on October 9. In 145 years of recorded data, stocks have only been priced richer once: the stretch around November 1999, when the ratio topped out at 44.19 just before the dot-com bubble burst.

That reading alone would be worth a pause. What makes the timing stranger is what the Federal Reserve did nine days before it. On September 16, the rate-setting committee voted 12-0 to raise the federal funds rate another quarter point, to a range of 3.75% to 4.00%. It was the fourth hike of this cycle. Kevin Warsh, confirmed in May as the Fed's 17th chair, told reporters afterward that inflation was too high and had been for too long. Minutes released October 7 showed most participants expect at least one more increase before the year is out.

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A Hiking Cycle Meeting a Record Valuation

Central banks typically raise rates to cool an economy, not to lean against a stock market already sitting near its most expensive level on record. The last two times CAPE got anywhere close to today's reading, the outcomes diverged. December 2021 came closest, with rates still near zero and the ratio reaching 38.6 before the 2022 selloff cut it down. The 1999 episode is the more direct analog: that cycle's 44.19 peak preceded a bear market that erased nearly 80% of the Nasdaq's value over the following two and a half years. The historical mean, by comparison, sits at 17.42, so today's reading runs more than double the long-run average.

Part of the unease traces to how narrow the gains have been. A lot of the index's advance has come from a small group of AI-linked megacaps, and only about a quarter of S&P 500 constituents have been confirming the broader rally even as the headline number keeps climbing. A market that's expensive on average and narrow underneath tends to be more fragile to any single disappointment than one where the gains are spread out.

The Nuance the Fed's Own Staff Pointed Out

What the Fed's own staff said next complicates the picture. In the same September meeting, Fed staff told the committee that this year's equity gains mostly reflected strong corporate earnings, not rising multiples, and that forward price-to-earnings ratios had actually fallen even as the index rose. That matters because Shiller's CAPE measure looks backward across ten years of inflation-adjusted earnings, which means it can stay elevated even when next year's profit outlook looks reasonable by comparison. Staff also flagged that spreads on AI hyperscaler debt widened from unusually low levels earlier in the year, a sign that some of the market's enthusiasm for the hundreds of billions in bonds funding the AI buildout has cooled at the margins, even if credit markets overall stayed calm.

What's Actually Pushing the Fed to Hike

Inflation, not stock valuations, is what's actually driving the Fed's hand. Headline PCE inflation, the Fed's preferred gauge, ran at 3.4% year over year in August, with the core measure at 3.0%, a touch cooler than the 3.3% consensus forecast but still well above the central bank's 2% target. The minutes pointed to two main culprits: lingering effects from tariffs pushing up goods inflation, which officials expect to fade, and the AI buildout, which is pushing up prices for technology-related consumer goods as demand for chips and components outruns supply. Several officials specifically worried that AI-driven effects are growing just as the tariff effects start to wane, leaving little room for inflation to cool on its own.

What to Watch Next

September CPI lands Wednesday, with economists expecting the headline rate to climb to around 3.7% from August's 3.4%, even as core inflation eases slightly. PPI follows Thursday. JPMorgan, Goldman Sachs, and Citigroup report third-quarter results this week too, kicking off a season where Wall Street consensus has S&P 500 earnings growing somewhere in the mid-to-high 20% range year over year, a test of whether the earnings growth that's been justifying today's prices is actually holding up. Futures currently point to the Fed skipping a hike at its October 27-28 meeting, with the real test shifting to December, where odds of another move have been climbing.

The Pulse24 Take

A CAPE ratio this high doesn't come with an expiration date. The market traded near similarly stretched multiples for years in the late 1990s and for much of 2020 and 2021 before either correction actually arrived, so timing a top off valuation alone has a poor track record. What's different this time is that the Fed is tightening into it rather than easing, which removes one of the supports that kept those earlier stretches going. The offsetting factor is real: earnings have actually grown into some of this year's gains, and a falling forward P/E alongside a rising index is a healthier combination than pure multiple expansion. The honest read is that valuation tells you remarkably little about next month's return and quite a lot about how much room for error the market is carrying. With inflation still running hot and a Fed that sounds unwilling to blink, that room looks thinner than it has in a while. Wednesday's CPI print and this week's bank earnings won't resolve the valuation question, but they'll say a lot about whether the earnings side of the equation keeps holding up its end.