NEW YORK (Reuters) - As the Federal Reserve kicks off a long-awaited rate cutting cycle, some investors are wary that richly valued U.S. stocks may have already priced in the benefits of easier monetary policy, making it harder for markets to rise much further. 

Investors on Thursday cheered the first rate cuts in more than four years, sending the S&P 500 to fresh records a day after the Fed reduced borrowing costs by a hefty 50 basis points to shore up the economy.

History supports such bullishness, especially if the Fed's assurances of a still-healthy U.S. economy pan out. The S&P 500 has gained an average of 18% a year following the first rate cut in an easing cycle as long as the economy avoids recession, according to Evercore ISI data since 1970.

But stock valuations have climbed in recent months, as investors anticipating Fed cuts piled in to equities and other assets seen as benefiting from looser monetary policy. That has left the S&P 500 trading at over 21 times forward earnings, well above its long-term average of 15.7 times. The index has climbed 20% this year, even as U.S. employment growth has been weaker than expected in recent months.

As a result, the near-term "upside from just lower rates is somewhat limited," said Robert Pavlik, senior portfolio manager at Dakota Wealth Management. "People just get a little bit nervous around being up 20% in an environment where the economy has cooled."

Other valuation measures, including price-to-book value and price-to-sales, also show stocks are well above their historic averages, Societe Generale analysts said in a note. U.S. equities are trading at five times their book value, for instance, compared with a long-term average of 2.6.

"The current levels can be summarized in one word: expensive," SocGen said.

Lower rates stand to help stocks in several ways. Reduced borrowing costs are expected to increase economic activity, which can strengthen corporate earnings. 

A drop in rates also reduces yields on cash and fixed income, diminishing them as investment competition to equities. The yield on the benchmark 10-year Treasury has dropped about a full percentage point since April, to 3.7%, although it has ticked up this week. 

Lower rates also mean future corporate cash flows are more attractive, which often boosts valuations. But the P/E ratio for the S&P 500 has already rebounded substantially after falling as low as 15.3 in late 2022 and 17.3 in late 2023, according to LSEG Datastream.

"Equity valuations were pretty reasonably full going into this," said Matthew Miskin, co-chief investment strategist at John Hancock Investment Management. "It's going to be hard to replicate the multiple expansion you just got over the last year or two over the next couple of years."

With any further increases in valuation expected to be limited, Miskin and others said earnings and economic growth will be key stock market drivers. S&P 500 earnings are expected to rise 10.1% in 2024 and another 15% next year, according to LSEG IBES, with third-quarter earnings season starting next month set to test valuations.

At the same time, there are signs that the promise of lower rates may have already drawn investors. While the S&P 500 has tended to be flat in the 12 months leading up to rate-cutting cycles, it is up nearly 27% in that period this time around, according to Jim Reid, Deutsche Bank's global head of macro and thematic research, who studied data since 1957. 

"You could argue that some of a potential 'no recession easing cycle' gains have been borrowed from the future this time," Reid said in the note.

To be sure, plenty of investors are undeterred by the elevated valuations and maintain a positive outlook for stocks. 

Valuations tend to be an unwieldy tool in determining when to buy and sell stocks - especially since momentum can keep markets rising or falling for months before they revert to their historical averages. The forward P/E ratio for the S&P 500 was above 22 times for much of 2020 and 2021 and reached 25 during the dotcom bubble in 1999.

Meanwhile, rate cuts near market highs tend to bode well for stocks a year later. The Fed has cut rates 20 times since 1980 when the S&P 500 was within 2% of an all-time high, according to Ryan Detrick, chief market strategist at Carson Group. The index has been higher a year later every time, with an average gain of 13.9%, Detrick said.

"Historically, equity markets have performed well in periods when the Fed was cutting rates while the US economy was not in recession," UBS Global Wealth Management analysts said in a note. "We expect this time to be no exception."