Warsh Warns: Inflationary Pressures Threaten Growth Stocks at Record Valuations

Fed Chair Kevin Warsh recently highlighted that inflation is broader than headline rates suggest. He pointed out that 54% of the 199 items in the personal consumption expenditures (PCE) price index, which is the Fed's preferred inflation gauge, had risen by more than 3% in the 12 months through summer 2026.

This is an awkward situation for companies in the S&P 500, whose growth has been built on higher-than-average profits. The next thing the market will need to deal with is a Federal Reserve that's keen on making businesses pay more for each dollar of borrowing, which could lead to investors paying less for each dollar of profit associated with their assets.

Higher interest rates tend to hit growth stocks hardest, as they compress the value of distant dollars and make borrowing more expensive. In 2022, aggressive Fed rate hikes created a brutal bear market, with the Nasdaq Composite falling by 33.1% and the Dow Jones Industrial Average losing 8.8%.

The complication is that stocks are starting from a much pricier perch than in 2022, with the S&P 500's cyclically adjusted price-to-earnings (CAPE) ratio at 41, a level exceeded only in 1999 and 2000.