Stock investors could be 'delusional' if prices continue to rise faster than earnings forecasts, Ed Yardeni says

• Stock valuations are soaring ahead of profit expectations, and investors should "come to their senses" and let prices cool, Ed Yardeni, the president of Yardeni Research, said in a Monday note.
• The S&P 500's forward price-earnings ratio climbed to 22 on Friday, landing about 3 percentage points above the cyclical peak in mid-February.
• Stock investors might be "delusional" if prices continue to outpace profit forecasts, Yardeni said.
• Economic risks sourced from stalled stimulus talks, closed schools, and rising COVID-19 cases serve as additional reasons stock buyers should wait for a more sustainable rally, he added.
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Investors should "come to their senses" and give the stock market some time to slow its roll, Ed Yardeni, the president of Yardeni Research, said Monday.

Equity prices are outpacing expectations for near-term profits, forming a price-earnings melt-up many have likened to the dot-com bubble of the late 1990s. The rally grew even more vulnerable through the start of earnings season as analysts' earnings estimates fell.

The S&P 500's forward price-earnings ratio climbed to 22 on Friday, about 3 percentage points above the cyclical peak seen in mid-February.

The index's forward price-sales ratio recently flashed a similar warning sign. The metric reached a record 2.32 in the week that ended on July 16, handily beating its past two cyclical highs. Investors could be in for a world of hurt if the decoupling of prices from profit forecasts carries on, Yardeni said.

"Are stock investors delusional? Not yet, but that could be an apt characterization of stock prices continue to rise faster than forward earnings," he wrote in a note to clients.

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Various economic risks also threaten the run-up, the strategist said. The US economic recovery could be slowed or even derailed by rising COVID-19 cases or a failure to pass additional economic stimulus on time. Separately, a shift to online classes for schools could create "a serious problem for parents' ability to return to work," Yardeni said, adding that another semester of online classes at colleges would slam nearby small businesses.

The looming economic dangers and overextended valuation metrics give investors even more reason to grow cautious of stocks' steady uptick. While the Federal Reserve "continues to keep the wild party going" with its various liquidity-boosting policies, it shields investors from "the harsh reality of the health crisis" and its economic fallout, Yardeni said.

"There's certainly mounting evidence that the V-shaped economic recovery during May and June is slowing or even stalling in July," the strategist said. "That could lead to more delinquencies and defaults on loans and bonds."

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