David Rosenberg, the widely cited chief economist and strategist at Gluskin Sheff & Associates Inc., said the Federal Reserve may be fueling another speculative stock bubble with loose monetary policies.

The central bank, which is undergoing a significant leadership change as board members retire, may err on the side of caution by keeping interest rates too low for too long, he said in a Jan. 11 report obtained by Newsmax Finance. That would continue to give investors more incentive to look for higher returns from stocks and junk bonds, which also carry greater risks.

President Donald Trump has a chance to shape the Fed’s direction by appointing members to its Board of Governors, which currently has four vacancies among its seven seats. Trump appointed Jerome Powell to be the next chair of the central bank, and his term begins next month.

"The elephant in the living room remains the central banks," Rosenberg wrote. "The prevailing view is that balance sheet tapering will be mild and that Jerome Powell will prove to be a dove. This may well be the most important psychological driver for the market — that a new and inexperienced Fed will not take the punchbowl away in the coming year."

The S&P 500 stock index has risen 21 percent in the past 12 months to a record high of 2,767.56, while the Dow Jones Industrial Average has gained 28 percent to 25,575.42. While some analysts have said President Trump’s tax and regulatory cuts have helped to drive the rally, others say the Fed’s easy money policies are the main reason.

The worry is that prices have gotten expensive compared with the underlying profitability of publicly traded companies. The 12-month forward price-to-earnings multiple for the S&P 500 is currently 18.4 times, compared with a 10-year average of 14.2, according to FactSet data.

“We had a 2017 calendar year where earnings in the U.S. are expected to rise 10 percent and yet the stock market rose 20 percent,” Rosenberg said. “We are into a situation where the president is boasting of his success in bolstering the stock market and calling for 30,000 on the Dow.”

Rosenberg sees a risk in the Fed’s remaining “a serial bubble blower” with policies that destabilize markets, as in the dot-com crash from a 2000 peak and the 2008 financial crisis. The collapse of those asset bubbles triggered recessions that prompted the Fed to stimulate the economy by lowering the cost of borrowing.

“No doubt we have the deregulation thrust, tax relief and a synchronized global expansion,” Rosenberg said. “But that has been priced in for a while and now the market rally has moved from a marathon to a race.”

The Fed has raised interest rates six times in the past two years, but the benchmark funds rate remains on the low side at 1.25 percent to 1.5 percent.

“Consider that the Fed may be far behind the curve at this point – at 1.5 percent on the Fed funds rate it is actually -0.7 percent in real or inflation-adjusted terms,” Rosenberg said. “Does this make sense at this stage of the cycle? Yet this is a key reason why valuations are so high today.”

Mismeasuring Inflation

The Fed may need to re-evaluate how it measures inflation, Rosenberg said. The Fed targets 2 percent inflation growth as a sign of healthy demand and economic growth, but the U.S. economy has struggled to reach that level. Deflationary forces like global competition, technological innovation and an aging U.S. demographic are frequently cited as structural forces in the economy.

“They [the Fed] are not ever willing to entertain the notion that a 2 percent core inflation target is inappropriate in today’s hyper-competitive and tech-advanced world, and the target should very well be 1 percent if not zero,” Rosenberg said.

Inflation may be show up in traditional indicators like personal consumption expenditures and the Consumer Price Index, but Rosenberg sees signs of it elsewhere, such as prices for stocks, fine art, corporate credit, real estate, commodities, previous metals and digital currencies like bitcoin.

"So Jeremy Grantham could well be onto something in his recent blow-off thesis," Rosenberg said, referring to the famed value investor’s Jan. 3 report. "But he is also intimating that we are heading into the final bubble phase and those don't end well."