Celina Jade
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Celina Jade in Markets at a glance,

IMF sounds the alarm on stock prices with two charts

Not to be left out of the crowd thinking the sky will fall on this market rally, the International Monetary Fund slipped out a note late Wednesday, sounding its own alarm over perceived stretchy stock valuations.

The comments were made in a note released ahead of a G-20 meeting in Australia later this month. Along with its stock warning, the IMF cautioned that downside risks for the global economy are on the rise, even as the fund expects the recovery to regain a foothold following a bumpy first half to the year.

The global body spoke of fresh worries in the form of geopolitical tensions, mostly of the Russian and Middle Eastern varieties, a sharp reversal of recent risk spread and declining volatility.

So here’s the clincher on those IMF stock worries:

“Valuations in virtually all major asset classes are stretched relative to past norms.”

The IMF noted those valuations have gone up despite mixed signals on the global recovery’s strength and geopolitical tensions. That’s while long-term bond yields have declined just about everywhere — Europe, the U.S. and most emerging economies. And capital flows going into emerging markets have remained positive, keeping equity and currency prices mostly stable since April. Of course, recent currency volatility makes the IMF statement slightly outdated.

With implied volatility back down to levels seen before Fed tapering talk began, theIMF said it’s concerned about a buildup of excessive leverage and underpricing of credit risk, which could be “abruptly corrected in the run-up to U.S. rate hikes or because of higher global risk aversion.”

The IMF uses the following charts to back up that assessment.

The low-volatility warning was heard from the Bank for International Settlementsearlier this week. Meanwhile, some of Wall Street’s biggest banks have been have been less alarmed over valuations.

Sven Henrich, founder and editor of NorthmanTrader.com, said he applauds the IMF for raising the issue of risk taking as being a systemic risk. “It was the BIS that was the most recent to issue warnings, now the IMF in regards to risk, while [central banks] are quiet,” he said.

“Notice [Federal Reserve Chairwoman] Yellen has completely stopped talking about it, even though prices are now higher,” Henrich said.

Where the IMF is overlooking a danger, he said, surrounds the big dollar rise against the yen USDJPY +0.40% and euro EURUSD -0.17%, which could have significant implications for multinationals.

“Unless multinational companies are perfectly hedged against the very large currency moves, they will see a negative earnings impact from the euro/yen,” said Henrich.

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