Sky-high stock valuations are increasing the risk of 'disorderly corrections' that could rattle the economy, IMF warns

• The IMF warns that elevated stock valuations risk causing financial market turbulence.
• US stocks, especially the S&P 500, are highly valued, posing correction risks.
• High concentration in AI stocks and household exposure could impact the economy.

The IMF is warning that elevated stock valuations are putting both financial markets and the global economy at risk of some turbulence.

"Valuation models indicate that risk asset prices are well above fundamentals, increasing the probability of disorderly corrections when adverse shocks occur," the organization said in its Global Financial Stability Report published this month.

US stocks in particular are highly valued, the IMF said. One measure the group cited is the S&P 500's 12-month forward PE ratio. Going back to 1990, it's currently higher than it's been 96% of the time. Fair value would put it at the 81st percentile since 1990, the group said.

Concentration is also a risk as investors pile into AI stocks, the group said. The so-called Magnificent Seven stocks make up 33% of the S&P 500.

Historically, extreme valuation and concentration levels have preceded stock market pullbacks and periods of dampened long-term returns. But investors aren't the only ones who may suffer if stocks decline meaningfully.

The broader economy may also feel the impact if a stock sell-off causes consumers to reduce their spending, the IMF said. It's a phenomenon known as the wealth effect, and gains on paper have been a strong psychological driver of consumer resilience, experts have said this year.

"Valuations of risk assets appear stretched, especially as the global economy slows, and concentration risks in certain segments have reached historic highs. History reminds us that asset prices can abruptly correct following booms in the technology sector," the organization wrote. "To the extent that stock market-driven wealth effects support strong consumption, a correction could have broader implications for the real economy."

This could especially be the case now, as 30% of household assets are in stocks, the organization said. That's hovering around record levels.

"A major portion of rising household exposure is to benchmark indices, in particular the S&P 500 (largely in 401k retirement accounts and through passive investment vehicles and exchange-traded funds)," the report said. "This exposure makes household balance sheets vulnerable to sharp corrections and prolonged declines in the index, potentially more so currently, given high concentration."