A strange thing happened during today’s Federal Reserve testimony in front of Congress: Janet Yellen told the world that she felt a particular sector on the equity markets was overvalued. More specifically: Janet Yellen decided it was in the Federal Reserve’s authority to knock some of the wind out of social media and biotech stocks. We’ve re-read the Fed’s mandate a few times looking for where it says “to dole out buy/sell recommendations on individual sectors” but we’re still not seeing it.
Specifically, Yellen said:
“…Valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.”
Didn’t Mrs. Yellen only just explain in front of the IMF that it wasn’t the Fed’s job to pop bubbles? Or perhaps she meant, it’s not the job of the Fed to pop bubbles, except bubbles in biotech and the social media space?
While we certainly agree (wholeheartedly, in fact) that social media stocks are some of the most overvalued internet equities we’ve ever seen — it still strikes us as interesting that Janet “we don’t pop bubbles” Yellen, just back-handed two bubbleicious sectors and gave a few stocks a bruising.
So when Wall Street says biotech’s lofty P/E’s represent “strong forward growth-potential” and the Fed just so happens to disagree – does this now make the Fed the analyst of last-resort? This takes us to a whole new level of “centrally-managed markets” indeed.
Let’s re-cap: Two weeks ago, the Bank for International Settlements strongly recommended that the Federal Reserve take action against rapidly forming bubbles in the marketplace. The BIS even recommended “bringing forward the next leg of the cycle” or risk “suffering a bigger bust later on” – a clear reference to policy measures intended to precipitate a collapse of said bubbles. A few days later, Yellen stood before the IMF and described the Fed’s lack of tools –and apparent willpower – to effectively deal with bubbles. Popping bubbles, it seemed, did not fall within the responsibilities or powers of Mrs. Yellen’s Federal Reserve.
We wrote at the time that perhaps such a non-interventionist position was merely cover for what might become a highly-interventionist and highly-unpopular set of forthcoming policies.
The Fed’s new policy tool
We may now be seeing just such an example of how the Fed intends to deflate such bubbles, and what tool they intend to use: Opinion. That is, extremely targeted opinions. Like you might find from a research analyst at say, a hedge fund.
Without enacting a single policy measure, the Fed may have just capped-out two of the equity market’s most hype-fueled sectors. While it may have worked from a strategic level, we don’t like what we’re seeing here at all.
This strikes us a scary new level of Federal Reserve micro-management. It’s bad enough that they watch the Russell and operate under the deeply flawed perspective that equity markets are somehow representative of the greater economy. But pulling the levers of public opinion to manage valuations in individual sectors? How far does this go?
What’s next, individual equities? What if Yellen thought that just FaceBook that was overvalued? Would she say so?
While it is still debated whether or not the Fed directly buys stocks — they are according to their own statements free to influence futures markets as a policy tool. They are also, according to many Fed analysts, within their rights to directly invest in stocks under an SPV. We know for example that many of the world’s central banks actively participate in the stock market, with the BoJ and Switzerland’s central bank being notable examples. Will those banks too begin to opine on valuations?
Central banks moving equities… Central banks trading equities… We liked it better when they just set rates.