Fed's Yellen: Stock Valuations 'Generally Are Quite High'

By Dan Strumpf And Pedro Nicolaci da Costa 

        Federal Reserve Chairwoman Janet Yellen weighed in on a growing debate among investors and market economists, suggesting the yearslong stock rally may have driven prices too high and raising concerns that debt-market investors are taking excessive risks.
        Ms. Yellen's remarks came during a conversation with International Monetary Fund Managing Director Christine Lagarde before an audience at the IMF's headquarters in Washington. Ms. Lagarde asked the central-bank chief about the possibility that the Fed's rock-bottom interest-rate policy is leading to bubbles in financial markets.
        "I would highlight that equity-market valuations at this point generally are quite high," Ms. Yellen said. "Not so high when you compare returns on equity to returns on safe assets like bonds, which are also very low, but there are potential dangers there."
        Other areas of possible concern are low differentials between the yields of riskier corporate bonds and safe-haven Treasury debt, and high levels of debt in the leveraged-loan market, she said.
        Ms. Yellen's comments harked back to former Fed Chairman Alan Greenspan's December 1996 comments that the stock market was showing signs of "irrational exuberance." That bull market continued until March 2000.
        Ms. Yellen's opinions are closely watched by investors even when they aren't directly tied to monetary policy. Last July, in a biannual report to Congress accompanying testimony by Ms. Yellen, the central bank sounded alarms about lofty prices of social-media and biotechnology stocks, prompting a short-lived retreat in those shares.
        On Wednesday, investors responded to the chairwoman's comments by driving stock prices down soon after the market opened. By the day's end, though, the market had largely recovered its losses. The Dow Jones Industrial Average fell as much as 195 points, or 1.1%, before recovering much of that ground, finishing the day down 86.22, or 0.5%, to 17841.98. The S&P 500 shed 9.31, or 0.5%, to 2080.15.
        While the declines were limited, Ms. Yellen's remarks echoed a worry lingering for many investors who continue to put money into stocks: that the bull market has run too far ahead of the prospects for earnings growth.
        "If you're already at very high valuations, the key question is are people going to be willing to come in and pay an even higher valuation level than you paid to buy these stocks from you," said Michael Ball, portfolio manager at Weatherstone Capital Management, which manages $750 million in Denver.
        Investors have believed, Mr. Ball, said, that as long as interest rates remain very low, stocks are a good place to invest. "Yeah, they're not cheap, but the money would continue to come in. I think some holders are starting to get nervous."
        Above-average stock valuations have for years been a concern for investors with a bull-market in equities now in its sixth year.
        The S&P 500 index now trades at 17.5 times the last 12 months of earnings, according to FactSet, up from 16.5 a year ago. The 10-year average price-to-earnings ratio for the index is 15.8.
        Ms. Yellen's warning over valuations is the latest cause for hand-wringing by investors, following a raft of data suggesting the U.S. has entered an economic rough patch. Last week, the Commerce Department said gross domestic product grew at a paltry 0.2% pace during the first quarter, while the country's trade deficit widened.
        At the same time, earnings growth all but stalled in the first quarter.
        With 417 companies reporting first-quarter results, earnings among companies in the S&P 500 are on pace to grow by just 0.2%, according to FactSet. While that is better than the 4.7% decline forecast at the end of March, it would be the weakest quarter for S&P 500 companies since 2012.
        Wednesday's pullback marked the second consecutive day of losses for major stock benchmarks, the latest move in a sideways year for stocks. The Dow is up just 0.1% for the year and has fallen 2.4% from its last record close reached in early April. The S&P 500 is up 1% for the year but is down 1.8% from its late-April record.
        "You came in hoping for a reason to buy stocks, and the market hasn't given us that for a while," said Larry Weiss, head of trading at brokerage Instinet in New York. "When something comes out [from the central bank] that's unscripted, or surprises people, people definitely use it as an excuse" to trade.
        Broadly, Ms. Yellen said Wednesday that "risks to financial stability are moderated, not elevated at this point."
        "There was a great deal that we missed before the crisis. I believe we are better prepared," Ms. Yellen said.
        The most recent episode of the Fed weighing in on the stock market came last July 15, when the Fed in a biannual report on monetary policy said, "Valuation metrics in some sectors do appear substantially stretched--particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year."
        That day, the S&P 500 fell 0.2%, while the Nasdaq Biotechnology Index fell 5.7% over three days.
        Since then, the S&P 500 has risen 5.4%, while the Nasdaq Biotechnology Index has soared 40%.
        Speaking later at the same conference, Kansas City Fed President Esther George offered a different view, saying she sees a more prominent role for financial stability considerations in the setting of interest rates.
        Highlighting "the important role that monetary policy plays in affecting risk appetite and risk premiums," Ms. George argued that the Fed's bond buys, "if pushed for an extended period of time... create vulnerabilities."
        The 2010 Dodd-Frank financial overhaul legislation gave regulators authority to wind down failing financial institutions that are so large that their collapse could threaten the stability of the broader financial system, a power Fed officials say they lacked during the crisis and which hampered regulators' ability to respond.
        However, Fed officials acknowledge addressing the issue of firms considered too large to be allowed to fail remains a work in progress.
        Ms. Yellen noted that regulators have imposed higher capital requirements to ensure financial institutions can withstand steep losses in a crisis. The Fed has made extensive use of bank stress tests to determine whether firms have enough capital to withstand a shock. It also has been working with international authorities to ensure standards do not vary too widely across borders.
        "A well-functioning financial sector promotes job creation, innovation and inclusive economic growth. But when the incentives facing financial firms are distorted, these firms may act in ways that can harm society," Ms. Yellen said. "Appropriate regulation, coupled with vigilant supervision, is essential to address these issues."
        Write to Dan Strumpf at daniel.strumpf@wsj.com and Pedro Nicolaci da Costa at pedro.dacosta@wsj.com
        (END) Dow Jones Newswires

        May 06, 2015 19:44 ET (23:44 GMT)

#FX
#Forex
#SaleForex
#FedsYellen
#StockValuation
#QuiteHigh
#YellenDecision