Stop Yellen! Stocks aren’t that expensive

Nobody likes it when the Federal Reserve chair calls stock valuations “quite high” and talks about “dangers there.” But data tell a different story to investors.

Janet Yellen put the touch on investors Wednesday cautioning that high stock valuations are a risk she’s watching — in an interview with International Monetary Fund Managing Director Christine Lagarde. There’s no question stock prices are on a tear.

But, historical data show stocks aren’t particularly expensive, they just aren’t cheap. While stock prices have been rising, earnings have been, too. That means the market’s price-to-earnings ratio is 18.5 based on operating earnings over the past 12 months, according to data from S&P Dow Jones Indices. That’s just about in line with the average on the same basis since 1988.

Check out the chart below. Stock prices, the green line, are shooting up. But look at the market’s valuation — the blue line. It’s pretty much right in line with the average trailing P-E since 1988 (the red line):

The market doesn’t look very expensive, but that doesn’t mean you should ignore Yellen’s warning completely. Just the opposite. A few reasons why Yellen’s warning is so important include:

* Investors have learned again and again fighting the Fed is generally a really bad idea. The Fed’s moves can make just about any line chart supporting stock prices at current levels go up in smoke. When the Fed moves, the market responds.

* P-Es can tell a different story based on how they’re measured. P-E based on operating earnings, which includes business costs but excludes interest and taxes, might be in line with the historical average. But looking at things another way, shows investors are paying much more for earnings than they did five years ago. The S&P 500 P-E based on trailing diluted earnings before extraordinary items is 21, says S&P Capital IQ.

* Threat of higher interest rates. Stock prices have been able to rise and justify their valuations because interest rates have been so low. But that boost might not last forever — something Yellen has something to say about. Even famed investor Warren Buffett indicated at the annual meeting for shareholders last weekend it could be harder for stocks to keep rising if investors aren’t willing to pay as much for corporate earnings if (or when) rates rise.

So stocks might not be as dangerously pricey as Yellen makes them out to be. But if there’s someone who can change that, it’s her.