Yellen cites 'potential dangers' in U.S. stock valuations

http://www.reuters.com/article/2015/05/06/us-usa-fed-yellen-idUSKBN0NR1JI20150506

by claywm • 11 years ago

77 81 11 years ago

pa5tabear• 11 years ago

Time to rebalance into bonds?

volkadav• 11 years ago

Some people (e.g. Bill Gross) think there's a bond bubble too. As bond prices and interest rates are inversely correlated, and it's hard for rates to go anywhere but up at the moment, imho they're probably right. I don't think anyone has a good handle on what asset classes are particularly safe (or, equivalently, will yield reasonable returns over the near-intermediate term) at the moment. My best guess is that P/E ratios are still fairly sane-ish, so my investments are in stocks atm. YMMV, I am not an investment adviser, etc.

gfodor• 11 years ago

"Rates don't have anywhere to go but up" is an argument I've seen used often but it doesn't hold water. First, the 10yr is at 2.25% right now, and nominal yields have hit negative in other countries, so we could go there. Or, rates could just churn for a decade. Both of these are completely plausible scenarios.

AnimalMuppet• 11 years ago

A bubble? No. A bubble is more than just "asset prices are higher than they should be".

Take stocks or real estate. The price goes up. People see the price going up. They buy, because they want to buy something where the price is going up so that they will make money. That buying increases demand without increasing supply, so the price goes up some more. That's a bubble - where the price goes up because people are buying because the price is going up (and so they think it's going to keep going up). It's a positive feedback loop.

But bonds... nobody's buying bonds because they think the price is going to go up. They're buying bonds because they think bonds are safe. But, in fact, bonds aren't very safe. The next direction interest rates will move is up; when they do, bond prices will fall. The longer term the bonds, the more the price will fall.

Note well: I am not an economist. I am not an investment advisor. This is my understanding of how things work, but it is not financial advice.

shawn-furyan• 11 years ago

I would note that reactionary investment allocation is generally relatively extremely expensive (due to transaction costs) for retail investors, and Fed statements aren't exactly under the radar.

Long, markets-wide, diversified positions tend to work out best for retail investors. Switching from heavy positions in one asset class to heavy positions in another tends to benefit investment firms, without reliably lowering investor risk. It's hard to guess where the market is going, and the transaction costs of frequent position changes, even at institutional investor rates, can quickly outstrip gains of a correct guess.

snowwrestler2• 11 years ago

IMO your balance should reflect your progress toward investing goals, not trying to outguess the market.

You know better than anyone about your own goals and progress, so you can make reliable decisions based on that information.

No one knows what the market is going to do next, and even if we assume a range of predictive accuracy, you're probably low in that range unless you spend a tremendous amount of time getting and analyzing economic data. So, you can't make reliable decisions based on that information.

spot3• 11 years ago

trying to time the market is a losing game.

the winning game: 1) invest in broad-based, low-fee indices as regularly as you can. 2) try to forget about them.

pyrrhotech• 11 years ago

No, bonds are the last place you want to be right now. That potentially sharp rise in longterm rates is highly dangerous for the bond market. If rates go up, bond prices go down. I'd stay in safe stocks or cash

sixdimensional• 11 years ago

Traditional economic logic says that bond prices have an inverse relationship with interest rates. That means if you buy bonds now, and interest rates shoot up, the underlying price/value of that bond will plummet. This is especially bad if you have callable bonds, because the bond holder can call them at any time, forcing you to essentially receive the value of the bond at the time of the call - even if the price/value has plummeted due to increasing interest rates.

Be cautious investing in bonds, and if you do, you might consider holding them to maturity if interest rates go up and prices/value goes down (and hope they don't get called).

I personally think it's a scary time - interest rates going up will have an effect on prices of bonds, stocks, and more. So while you earn more interest if you own fixed income assets, the value of those assets decreases and you can get stuck.

That said... IMHO, the raising of interest rates... I think really needs to start happening before the artificially low rates creates a different kind of animal altogether.

kolbe5• 11 years ago

Back when the Fed started its first QE program, I thought it was a pretty risky bet. I felt that all QEs have gone far beyond providing emergency liquidity, and instead conceded that asset prices were/are unsustainably high. But one thing that would bail out an overpriced market for assets was to have a domestic economic revolution that rivaled WW2 rebuilding or the tech revolution. So, their reaction was to actually continue to prop up asset prices. Forget the Taylor Rule and whatever. The Fed wanted to give asset prices a floor. By attempting to give asset prices a floor, it was simply buying us time to have a solid economic revival that goes beyond juicing GDP with credit and entitlements.

That was over five years ago. We chose to invest this capital in three routes. One is domestic oil production. It may be a little early to tell, but it looks like all that money will have been wasted. So, net effect on the economy may end up being that we wasted time, money and natural resources in building useless machines in the middle of nowhere that added an unfathomable amount of carbon to our atmosphere. The other is Silicon Valley tech and biotech. So far, that has not been a bust, but I'm not sure it's playing out quite as well as we need it to. SV has a strange dynamic where the efficiencies and labor displacements that it has been bringing about may actually be harming our economy. Biotech sounds cool, but it may just be a new rent seeking industry that sucks off the teat of inefficiencies of socialized medicine.

Needless to say, I don't think any of these industries are anywhere near the level of revolution they need to be to actually justify asset price levels. They can be good, but I doubt that good.

So, regarding 'potential dangers' in asset price overvaluations. Umm, no shit?

protomyth5• 11 years ago

"One is domestic oil production. It may be a little early to tell, but it looks like all that money will have been wasted. So, net effect on the economy may end up being that we wasted time, money and natural resources in building useless machines in the middle of nowhere that added an unfathomable amount of carbon to our atmosphere."

How is the money wasted given the large production and downward price pressure on energy? This shift in price of gas at the pump has done quite a lot for the working poor in terms of cash on hand.

Also, "middle of nowhere" as a description is a bit insulting and I don't think most people in a city would like to have oil wells next door. Some things happen away from the coasts.

throwaway9011• 11 years ago

We are mixing up a few things here.

1) Has the oil boom benefited anybody? Yes it has.

2) Has the oil boom benefited morally/politically sympathetic groups, such as the American poor? Yes it has.

3) Will the oil boom benefit humanity as a whole, over the medium to long term? The jury is still out on this one, and the answer may in fact be no.

It is perfectly possible to do things that are beneficial in the short run but ruinous in the long run.

kolbe5• 11 years ago

The downward pressure on oil may not have actually been caused by US oil production (though it may have). I think the bigger influence on oil prices is that gulf nations have maybe a 100 year supply of oil at their current output rates, but world reliance on fossil fuels doesn't look like it will last that long. Though, domestic production may have influenced this too. I'll grant you that as a real possibility. One thing this machinery does offer us that I didn't mention is the option to produce domestically if prices ever do rise to the point of that being profitable again. And that option isn't necessarily worthless.

"Middle of nowhere" was intended to elicit imagery, not insult. Various places that are in the middle of nowhere are actually my favorite ones in the world.

derf_• 11 years ago

How is the money wasted given the large production and downward price pressure on energy?

The latter is exactly what causes the former to be wasted. If demand drops (or even merely does not rise as quickly as expected), then the price drops. If you were relying on high prices when you made your decision to invest more money to increase capacity, then what previously looked like a good idea may now be a bad one.

When your break-even price is $60 to $65/barrel and prices fall below that, your net return is negative. But the best part is you don't even get to stop producing. The costs for most oil sources must be paid largely up-front, and your marginal cost may be only $20 to $30/barrel. So when oil drops to $50/barrel, you can choose between continuing to produce at a loss of $10 to $15/barrel over the life of the well, or stop producing and suffer a much, much larger loss. That keeps supply high and prices low.

One oil source that does not have large up-front costs is fracking. Or, more exactly, fracking sites only last 18 months or so before production slows to a trickle, so you have a much smaller time horizon to recoup up-front costs. So the amount of fracking will very likely decline quickly. But viewed from an economy-wide standpoint, there was still plenty of malinvestment here: drilling equipment rental, trucking, rail, etc., require large capital outlays but carried high prices when oil prices and thus demand was high. As demand drops, they may not be worth the amount invested in them.

sedachv• 11 years ago

Also, "middle of nowhere" as a description is a bit insulting and I don't think most people in a city would like to have oil wells next door. Some things happen away from the coasts.

That's what oil industry PR wants you to assume.

Los Angeles has over 1,800 active oil wells, one on the grounds of a public high school, one across the street from a hospital: http://www.nileguide.com/destination/blog/los-angeles/2010/0...

http://www.vice.com/video/oil-of-l-a--3

There are thousands more in and around residential areas in Los Angeles and Orange counties.

There is even fracking and waste water dumping going on in the city:

http://www.cafrackfacts.org/fracking-in-california/where-is-...

http://baldwinhillsoilwatch.org/

mason240• 11 years ago

It may be a little early to tell, but it looks like all that money will have been wasted. So, net effect on the economy may end up being that we wasted time, money and natural resources in building useless machines in the middle of nowhere that added an unfathomable amount of carbon to our atmosphere.

This is entirely predicated on the assumption that cheap solar energy will be available within the next ten years.

kolbe5• 11 years ago

Or a breakthrough in battery tech, or fusion, or any number of the pie-in-the-sky ideas that get floated every so often.

eli_gottlieb3• 11 years ago

Biotech sounds cool, but it may just be a new rent seeking industry that sucks off the teat of inefficiencies of socialized medicine.

Uhhhh... what socialized medicine? In the USA we just plain don't have socialized medicine.

kyledrake4• 11 years ago

Chart one, DJIA, 1982 to 2014: http://i.imgur.com/29GT453.png

Note that it's even higher now on the end of that chart, so push it to 18,000 and you've got the comparison.

That chart, at a bare minimum, whether you think we're dealing with "irrational exuberance" or not, should tell you that we're in an exceptional period in the stock market.

Chart two, federal funds rate, 1954 through 2009: http://upload.wikimedia.org/wikipedia/commons/thumb/3/31/Fed...

That funds rate is still that low. Whether you think it's too low or not, it's pretty obvious that this is an exceptional period for access to low-interest money.

I'm watching the real estate market spike up much faster than wages (again), and billions get poured into tech companies who's business model really just isn't there and/or heavily depends on advertising (advertising rates collapsed after 2000, by a lot). I was worried about the valuations a year ago, and now they're even higher. And of course, it's pushing a lot of private valuations up too. The more money publicly traded corporations have, the better your chances of selling a private company at a high value, or going public without good fundamentals.

I think there's just too much money sloshing around right now. Excess money doesn't go into CPI anymore, it more often creates valuation fevers. I don't think the overnight rates should have been this low for so long. And I'm pretty worried about what's going to happen when they finally start raising them, but not as worried as what happens if they continue to leave them as-is.

EliRivers• 11 years ago

Chart one, DJIA, adjusted for inflation:

http://home.earthlink.net/~intelligentbear/dj-lt-infl.gif

When you take inflation into account, it doesn't look nearly so interesting.

MarkPNeyer• 11 years ago

it actually looks like things are getting _more_ stable.

Pxtl2• 11 years ago

Much better. Also logarithmic, which was another failing of the above graph. With a line of best fit!

Yes, if the market is overinflated, it's because growth itself has failed to happen.

Retric• 11 years ago

A Lograthmic chart is much better, but when you add in dividend reinvestment and inflation adjustment you get a vary different chart.

dpierce9• 11 years ago

^This. If you don't take into account inflation and don't plot on a log scale, you can't make any sense of a long term stock or bond price chart. It really doesn't make any sense (though it would be nice if this chart were also a broader index).

solomatov2• 11 years ago

DIJA chart doesn't include reinvested dividends.

cylinder• 11 years ago

We need to get back to normal interest rates asap. The whole situation has become absurd, every single asset class is ridiculous. Force policymakers to make real changes that boost global growth, not simply lazy monetary policy. When the wealthy stop getting so rich by frothy asset prices, they'll clamor for it too.

In this case I'm not too worried about public equities, it seems to be everything else right now.

VLM• 11 years ago

That interest rate policy will have some interesting effects on national/state/local/corporate debt payments.

eli_gottlieb3• 11 years ago

Force policymakers to make real changes that boost global growth, not simply lazy monetary policy.

The basic problem is that every major economy is simultaneously trying to restart its growth through exports. We're in a currency war.

fchollet• 11 years ago

The DJIA is essentially useless [1]. We should look at the SP500 instead, or the Nasdaq, or... anything that's at least somewhat representative of the state of the US stockmarket.

[1] http://www.fool.com/investing/general/2014/04/18/why-the-dow...

kyledrake4• 11 years ago

Here's the Nasdaq chart, '73 to Feb 2015: http://i.imgur.com/gyyQtae.png

kolbe5• 11 years ago

This is something that people like to spew, but the DJIA has two nice properties that make it worth referencing sometimes.

(1) Its correlation with the S&P 500 is insanely high. So, just using it as a proxy for the S&P is fine.

(2) We've tracked the DJIA going back over a hundred years, so that data is readily available.

Overall, the S&P 500 is a better index, but criticizing someone for using it in their analysis isn't worth the distraction from their actual thesis.

Spooky23• 11 years ago

Have you looked at the S&P 500 chart for the time period in question?

whybroke• 11 years ago

The S&P 500 and Nasdaq have the same shape.

hueving• 11 years ago

Chart reading is stupid. You could cut that chart off before any of the tech bubble starts and you would be able to say the same thing over and over about the market being in an 'exceptional period'.

1990 - reaching all-time highs, 'exceptional period'

1991 - reaching all-time highs, 'exceptional period'

1992 - reaching all-time highs, 'exceptional period'

1993 - reaching all-time highs, 'exceptional period'

1994 - reaching all-time highs, 'exceptional period'

1995 - reaching all-time highs, 'exceptional period'

I think there's just too much money sloshing around right now.

Why? Are you the tastemaker in how much money supply there should be? We have inflation numbers to help dictate that. If inflation isn't above its target, then there isn't too much supply.

mayukh• 11 years ago

I don't know why you're getting downvoted (I upvoted you). You make a good point. Valuations are both subjective (your view) and relative (where else can I put my money). This 'boom' could end tomorrow or go on for years to an end. Being early on a market call is the same as being wrong..which is why speaking about frothy valuations is one thing, putting money to work based on those presumptions of frothiness is playing with fire.

aNoob7000• 11 years ago

If the U.S. stock market is really fairly valued then moving rates up wouldn't be such an issue. Yet, the Federal Reserve can't talk about moving rates up a quarter point six months in the future without the market taking a dive.

Why the anxiety??

bduerst2• 11 years ago

Exactly. Trying to predict a "bubble burst" using line charts alone is analogous to scrying with tea leaves.

With the housing bubble, it was very clear that the traditionally correlated mortgage and rental prices had separated, signalling that mortgages were in a bubble.

Pointing a chart and saying it's high doesn't prove anything. You need to show signals other than the federal reserve moderating inflation (which is normal).

kyledrake4• 11 years ago

Tastemaking? Okay, I can try that.

I was visiting a friend last night, who is looking to buy her first house.

She told me that she's been having trouble because people are showing up for $300k houses ($150-200k 5 years ago) and offering, same day, without an inspection, $600k cash offers.

That tastes funny.

Pxtl2• 11 years ago

Fit an exponential curve to that DJIA graph and I think it's hard to say if we're up or down.

adaml_6232• 11 years ago

Plot it with a logarithmic y axis. Doesn't look as bad, does it?

rhino369• 11 years ago

I'd probably look at the S&P Price/Earnings Ratio. You can't just go by price because what if the US economy really is growing faster or slower? The stock market should reflect that, and it shouldn't be growing at some constant rate.

P/E ratios are a bit high compared to average, but not crazily so.

solomatov2• 11 years ago

P/E highly depends on an interest rate. If interest rates are low, higher P/E are justifiable.

arenaninja• 11 years ago

I'm no economist, but I agree with this.

One, the real estate market is once again through the roof while homeownership is at the lowest it's been in decades. Seems to me that wealthy people, domestic and foreign, are parking their money in real estate assets, and banks refuse to go through with the foreclosures they've been holding onto since around '09

Next is oil. It's possible that the full brunt of the collapse in oil prices hasn't been felt, but most oil companies were profitable to the tunes of billions of dollars, again. Profit margins were only off about 30% from last quarter, and the predicted merger/acquisition apocalypse analysts were predicting hasn't materialized, while oil prices are on their way to recovery, even though the dollar is ridiculously strong against other currencies at the moment

Hiring has pulled back, wages are stagnated, consumer spending is down, but the stock market is at record highs. Honestly, for the most part I wish the government had let it crash

cdnsteve• 11 years ago

“What is needed is a culture that induces bankers to do the right thing even if nobody is watching,” Lagarde said in her prepared remarks.

Do bankers now get paid for doing the right thing? Because if they don't, it's not going to happen.

spot3• 11 years ago

how about we fine them if they do the wrong thing (and even throw them in jail if its bad enough).

altcognito3• 11 years ago

It's really too late by then, and you're counting on enforcement which we really lack right now.

adaml_6232• 11 years ago

It would be a good intermediate step to define 'the right thing'.

And then to pay them for doing the right thing.

toomuchtodo2• 11 years ago

Or perhaps put a framework into place that prevents them from doing anything other than the right thing?

ArkyBeagle• 11 years ago

There is a strong possibility that nobody actually knows what the right thing is. There is a story that says the mortgage mess was done largely for reasons of "for the social good" and that people believed that.

There may be somebody, but they aren't known, don't get listened to or otherwise don't exist for purposes of this sentence. The existence of a Micheal Burry* does not keep a bubble from forming.

*A "The Big Short" person of interest.

But yeah - I'd expect a drop in stock prices once interest rates hike a bit. We have in effect a generation (perhaps two) that has known nothing but very low rates.

eghri• 11 years ago

Defining the "right thing" to do is the crux of the issue. If it was easy, we wouldn't need the stock market, banks, VC funds, or any of these things because we could just have our committee of experts make the optimal investments. As people on this site should know, sometimes the best long term decisions seem like wild long-shots at the time (like investing in a start-up).

It might be easier to define the "wrong thing" to do, but even that is usually short for the "wrong thing to do yesterday". Most people don't go and make the exact same mistake again unless they believe there is a convincing reason why This Time Is Different™.

Common sense "wrong things" also bring tradeoffs or don't have clear policy mechanisms. Even if we all agreed the stock market was overinflated, how can we deflate it without restricting valid investment and hurting the broader economy?

mahyarm• 11 years ago

In any large enough group of people, you will statistically get bad actors. It's like trying to get rid of all memory corruption bugs in C++ with a culture of good programing. It's still going to happen.

You need _infrastructure_ in place to make the bad actors irrelevant.

snowwrestler2• 11 years ago

Agreed. At some point it becomes too expensive--either in direct costs or in opportunity costs--to engineer away every possible bad thing that can happen. The most productive systems are those that efficiently balance prevention against mitigation and recovery.

As we look at regulation of the financial system, I would argue that we should not lose sight of the systems we already have for mitigation and recovery. When they were most needed, they worked well.

The nature of a market economy is that people are free to make decisions, including accidentally bad and purposefully bad decisions. I don't think it's possible to eliminate the bad without also unintentionally limiting some of the future good.

NoMoreNicksLeft2• 11 years ago

Memory bugs aren't intelligent. You never find one changing it's nature or behavior to avoid debugging (even if it feels that way sometimes).

Bankers are humans, the most intelligent species we know of. They want to be bad actors, and they're constantly dreaming up ways to do it better.

Any infrastructure or regulations will eventually (and probably soon) be co-opted. Furthermore, given the nature of regulations (that 1% are in control of them, and the other 99% are beholden), once co-opted they will be impossible to modify to repeal. Now they help the bad guys do bad things, and they're not going to let you take them away.

It gets worse, because humans are intelligent. If they spent all that effort co-opting these regulations, might it not be better to write the regulations in the first place? Much less effort for something even more adapted for them to do bad things.

And since the nature of legislatures is that 0.01% are on control of them, and the other 99.99% are beholden to them, once co-opted it's impossible to repair the damage.

So no, we don't need infrastructure. We need that like we need a hole in the head.

dataker• 11 years ago

The irony here is that Yellen is the chair of the Federal Reserve.

It's analogous to Malboro's CEO warning smokers about lung cancer.

jpmattia• 11 years ago

Yes, I'm surprised that didn't make bigger headlines.

"Hoocoodanode that our easy monetary policy would have inflated stock prices?!"

fredkbloggs• 11 years ago

If an arsonist burned down every forest in North America, then had the stones to give interviews in which he complained about air pollution, we'd properly call him a dangerous nut and lock him up for life.

Apparently if you're an economist and you do the same thing, you are instead given the world's most powerful job.

Yellen cites 'potential dangers' in U.S. stock valuations

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