Yellen Says Stock Valuations ‘Quite High,’ Bond Yields Low

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Federal Reserve Chair Janet Yellen, surveying the financial landscape for signs of bubbles after more than six years of near-zero rates, warned that both stocks and bonds are richly valued.

“I would highlight that equity-market valuations at this point generally are quite high,” Yellen said in Washington on Wednesday in response to a question at a forum on finance. “Now, they’re not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there.”

Yellen said bond yields “could see a sharp jump” when the Fed raises its benchmark interest rate. Most Fed officials predict that will happen this year for the first time since 2006.

The prospect of an adverse market reaction could make the Fed wary about raising rates too soon and too rapidly, said Thomas Costerg, an economist at Standard Chartered Plc in New York.

“There’s incremental concern about the stock market, and I think there’s an underlying fear about the stock-market reaction to when the Fed starts to tighten,” he said. “That may be something making the Fed cautious before raising rates.”

Stocks and Treasuries dropped after Yellen’s comments. The Standard & Poor’s 500 Index fell 0.5 percent to close at 2,080.15 in New York, after earlier losing more than 1 percent. Ten-year yields rose almost six basis points, or 0.06 percentage point, to 2.24 percent, according to Bloomberg Bond Trader data.

Not Worried

Another Fed policy maker said he wasn’t overly worried about stock valuations.

“I don’t at this moment have reason to be intensely concerned about the valuation level of the equity markets,” Federal Reserve Bank of Atlanta President Dennis Lockhart said in a response to a reporter’s question.

Treasury yields have been held down by three rounds of large-scale asset purchases by the Fed that have swelled its balance sheet $4.47 trillion. Slow economic growth and even lower yields in Europe and Japan are also having an impact.

The S&P 500 is trading near its record close of 2,117.69 on April 24. The benchmark gauge for American equities has nearly tripled since plunging to a 12-year low during the financial crisis in March 2009.

The S&P 500 trades at 18.4 times earnings, near a five-year high of 18.7 times reached in February. Analysts predict profits will drop for the first three quarters of 2015.

Financial Instability

Yellen said that after holding rates near zero since December 2008, the Fed must be on the lookout for threats to financial stability. She spoke in response to questions from International Monetary Fund Managing Director Christine Lagarde during a panel discussion at the “Finance & Society” conference sponsored by the Institute for New Economic Thinking.

She said she sees signs of “reach for yield” in the market for leveraged loans, and that bond yields could jump when the central bank raises its benchmark rate.

“Long-term interest rates are at very low levels,” Yellen said. “We could see a sharp jump in long-term rates” after liftoff.

“We saw this in the case of the taper tantrum in 2013, where there was a very sharp upward movement in rates,” she said in reference to the episode in the middle of that year, when then-Chairman Ben S. Bernanke suggested that the Fed could start tapering its bond purchases in the next few meetings.

Reasonably Confident

Yellen’s comments Wednesday were her first since the April 28-29 meeting of the Federal Open Market Committee, which repeated it won’t raise interest rates until it sees continued improvement in the labor market and its “reasonably confident” that inflation will move back up toward the central bank’s 2 percent target.

“The key is to ask whether valuations are so high that they are divorced from reality,” said Brian Jacobsen, who helps oversee $250 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. “Valuations have been significantly higher in the past, so they are within the range of normal, if there is such a thing as normal.”

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