Little evidence investors should care about Fed's warning on equities

WASHINGTON: Investors wary of Federal Reserve chairs warning about overvalued stock markets need not fret: Such remarks tend not to have a lasting effect.

Fed Chair Janet Yellen said on Wednesday that equity market valuations are "generally quite high," saying there are "potential dangers" with where shares are trading. The market reaction was modest at first, but major averages lost ground in the late afternoon, with the effect of her words unclear.

So far, her statements have tended to have a short-lived effect on shares, matching that of her predecessors.

"As talented a person as Janet Yellen is, I wouldn't necessarily use her as my portfolio advisor for equities," said Rick Meckler, president of investment firm LibertyView Capital Management in Jersey City, New Jersey.

The most famous remark remains then-Chair Alan Greenspan’s "irrational exuberance" comment on Dec. 5, 1996, when he questioned whether the Fed would know when such exuberance has "unduly escalated asset values, which then become subject to unexpected and prolonged contractions," specifically mentioning Japan's markets.

Traders initially took his line as a warning for U.S. stocks. They sold off the next day, but less than 3-1/2 years later, the Nasdaq Composite index <.IXIC> had nearly quadrupled. Greenspan in later years shrugged off the suggestion that the Fed could have done anything about the gains in tech shares in the late 1990s.

His successor, Ben Bernanke, did not discuss valuations often and indeed, for a good part of his tenure, the market was suffering in the wake of the financial crisis. In February 2013, however, he said he did not see a bubble forming.

Yellen first waded into the stock-picking realm by looking at sectors. She said on July 15, 2014, that valuations for biotechnology, social media and smaller companies "appear to be stretched."

Those comments came after a substantial correction in those names already, so Yellen struck some observers as late in her assessment. There is no doubt she had an abbreviated effect: The Global Social Media ETF fell 3.3 percent in three days and eventually bottomed in mid-December, having lost 9.1 percent from its July 14 close. Since then, those stocks have gained 12.5 percent.

Biotechs, meanwhile, suffered a brief decline: The Nasdaq Biotechnology Index ETF (IBB) fell 5.8 percent in the three days after July 14. Since then, the index is up 40 percent, so if it was overvalued then, it is really overvalued now.

On Wednesday, Yellen did temper her remarks by saying that she did not see any bubbles forming at the moment, and she described risks to financial stability as "moderated, not elevated."

What matters, then, is how the Fed reacts. If the Fed begins to raise rates, the perceived risk in stocks will be altered given higher borrowing costs.

"She's stating the blatantly obvious. She's saying what's propping up the market is very low interest rates," said Stephen Massocca, chief investment officer at Wedbush Equity Management LLC in San Francisco. "She's saying that there's a concern when rates go up, equity valuations will look worse."- Reuters