Yesterday’s prepared testimony by Fed Chair Janet Yellen created a lil controversy, and a mild bit of equity selling pressure for the following remarks:
However, signs of risk-taking have increased in some asset classes. Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms.
To be honest, I really don’t get what all the fuss is about. I get that commenting on equity valuations is not the mandate of the Federal Reserve. But equity valuations have never been more dependent on the actions of the Federal Reserve. Ms. Yellen knows that in the last 20 years, Fed policy has been knee deep in the last two most fabulous asset bubbles in the last century, both of which failed miserably and caused our economy to go into fairly deep recessions, with the last one nearly destroying the financial system as we know it.
So while you are relieving your wedgie, remember that one of the major levers the Fed has to pull in their endeavors to set monetary policy is communication. Under Chairman Bernanke, the Fed took this to new levels in the aftermath of the Financial Crisis, and based on Yellen’s first presser back in January and yesterday’s remarks, she seems dead set on stating what’s on her mind.
So just as Ms. Yellen is talking rates lower, she is talking up the risks in speculative equity investing. Seems like fairly sound advice to me. So you ask yourself the age old sacred question, What Would Janet Do? Well, it seems clear she is buying incrementally LESS bonds and is a seller of high-flying equities that have little valuation support. Seems like a very reasonable strategy given where we are in the perceived economic recovery.
It appears that despite the Fed’s intention to end QE in October their continued dovish stance on rates indicates just how delicate we are at this stage of the recovery. While unemployment is at the lowest level in 5 years, corporate sales growth is meh, earnings growth is massaged, GDP is expected to be well below long term averages, housing appears stalled and most of all the economy does not seem ready for interest rates to rise, or at least the Fed does not think it is ready for it. So with equities again at all time highs, and despite the Fed’s miserable track record at forecasting much of anything, maybe filing away Fed Chair Yellen’s remarks in a place where your best risk management instincts lie would be prudent.