US Fed Chief Janet Yellen’s Irrational Exuberance Warnings 2015 Edition

In July 2014, in reporting to both houses of the US Congress, US Federal Reserve chairwoman Ms. Janet Yellen mimicked Alan Greenspan’s "irrational exuberance" warning in 1996, with an admonition that some segments of the equity markets have been “substantially overstretched”.

Given that stocks have reached record upon record highs after this appearance, this only means the markets has been ignoring or fighting the FED. 

Another way to see this is that the FED has “lost control” over the asset bubbles.

Yet in the same appearance before the US congress, yesterday, Ms. Yellen reiterates her irrational exuberance warning for 2015.

From Ms. Yellen’s Monetary Policy Report to the US Congress dated February 24

From page 22 (bold and italics mine)

Over the second half of 2014 and early 2015, broad measures of U.S. equity prices increased further, on balance, but stock prices for the energy sector declined substantially, reflecting the sharp drops in oil prices (figure 32). Although increased concerns about the foreign economic outlook seemed to weigh on risk sentiment, the generally positive tone of U.S. economic data releases as well as declining longer-term interest rates appeared to provide support for equity prices. Overall equity valuations by some conventional measures are somewhat higher than their historical average levels, and valuation metrics in some sectors continue to appear stretched relative to historical norms. Implied volatility for the S&P 500 index, as calculated from options prices, increased moderately, on net, from low levels over the summer.

From page 24

The financial vulnerabilities in the U.S. financial system overall have remained moderate since the previous Monetary Policy Report. In the past few years, capital and liquidity positions in the banking sector have continued to improve, net wholesale shortterm funding in the financial sector has decreased substantially, and aggregate leverage of the private nonfinancial sector has not picked up. However, valuation pressures are notable in some asset markets, although they have eased a little on balance. Leverage at lower-rated nonfinancial firms has become more pronounced. Recent developments in Greece have rekindled concerns about the country defaulting and exiting the euro system. 

With regard to asset valuations, price-to-earnings and price-to-sales ratios are somewhat elevated, suggesting some valuation pressures. However, estimates of the equity premium remain relatively wide, as the long-run expected return on equity exceeds the low real Treasury yield by a notable margin, suggesting that investors still expect somewhat higher-than-average compensation relative to historical standards for bearing the additional risk associated with holding equities. Risk spreads for corporate bonds have widened over recent months, especially for speculative-grade firms, in part because of concerns about the credit quality of energy-related firms, though yields remain near historical lows, reflecting low term premiums. Residential real estate valuations appear within historical norms, with recent data pointing to some cooling of house price gains in regions that recently experienced rapid price appreciation. However, valuation pressures in the commercial real estate market may have increased in recent quarters as prices have risen relative to rents, and underwriting standards in securitizations have weakened somewhat, though debt growth remains moderate

The private nonfinancial sector credit-to-GDP ratio has declined to roughly its level in the mid-2000s. At lower-rated and unrated nonfinancial businesses, however, leverage has continued to increase with the rapid growth in high-yield bond issuance and leveraged loans in recent years. The underwriting quality of leveraged loans arranged or held by banking institutions in 2014:Q4 appears to have improved slightly, perhaps in response to the stepped up enforcement of the leveraged lending guidance. However, new deals continue to show signs of weak underwriting terms and heightened leverage that are close to levels preceding the financial crisis.

As a result of steady improvements in capital and liquidity positions since the financial crisis, U.S. banking firms, in aggregate, appear to be better positioned to absorb potential shocks—such as those related to litigation, falling oil prices, and financial contagion originating abroad—and to meet strengthening credit demand. The sharp decline in oil prices, if sustained, may lead to credit strains for some banks with concentrated exposures to the energy sector, but at banks that are more diversified, potential losses are likely to be offset by the positive effects of lower oil prices on the broader economy. Thirty-one large bank holding companies (BHCs) are currently undergoing their annual stress tests, the results of which are scheduled to be released in March.

Leverage in the nonbank financial sector appears, on balance, to be at moderate levels. New securitizations, which contribute to financial sector leverage, have been boosted by issuance of commercial mortgage-backed securities (CMBS) and collateralized loan obligations (CLOs), which remained robust amid continued reports of relatively accommodative underwriting standards for the underlying assets. That said, the risk retention rules finalized in October, which require issuers to retain at least 5 percent of any securitizations issued, have the potential to affect market activity, especially in the private-label residential mortgage-backed securities, non-agency CMBS, and CLO sectors.

Reliance on wholesale short-term funding by nonbank financial institutions has declined significantly in recent years and is low by historical standards. However, prime money market funds with a fixed net asset value remain vulnerable to investor runs if there is a fall in the market value of their assets. Furthermore, the growth of bond mutual funds and exchange-traded funds (ETFs) in recent years means that these funds now hold a much higher fraction of the available stock of relatively less liquid assets—such as high yield corporate debt, bank loans, and international debt—than they did before the financial crisis. As mutual funds and ETFs may appear to offer greater liquidity than the markets in which they transact, their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions.

Again we see authorities dishing out warnings after warnings on asset bubbles albeit on a sanitized basis—there is a growth in the risk environment but the economy is strong yada yada yada…

And for me, current imbalances have been so apparent that it can't be ignored anymore. And these warnings seem more about escape outlets, so that when the real thing occurs, authorities will jump in defense: I saw and warned about it...so it is not my fault—a veneer.

And speaking of former Fed chief Alan Greenspan. At one of the latest investment conference, Alan Greenspan had a dire outlook for the markets.

Here is Mac Slavo on Alan Greenspan’s gloomy predictions (bold and italics original)

Greenspan recently joined veteran resource analyst Brien Lundin at the New Orleans Investment Conference to share some of his thoughts. According to Lundin, the former Fed chairman made it clear that the central bank is facing a serious problem and one that will have significant ramifications in the future.

We asked him where he thought the gold price will be in five years and he said “measurably higher.”

In private conversation I asked him about the outstanding debts… and that the debt load in the U.S. had gotten so great that there has to be some monetary depreciation. Specially he said that the era of quantitative easing and zero-interest rate policies by the Fed… we really cannot exit this without some significant market event… By that I interpret it being either a stock market crash or a prolonged recession, which would then engender another round of monetary reflation by the Fed.

He thinks something big is going to happen that we can’t get out of this era of money printing without some repercussions – and pretty severe ones – that gold will benefit from. 

Record stocks in the face of record imbalances and record warnings from authorities