While Federal Reserve Chief’s Janet Yellen’s testimony on Tuesday before the Senate did not signal a significant change in Fed policy, biotech and internet stocks sold off on her comment that valuations of stocks in these sectors were “stretched.” Yellen also stated that if employment numbers continue to improve, interest rate hikes may occur earlier than originally planned: “If the labor market continues to improve more quickly than anticipated by the [Fed], then increases in the federal-funds rate target likely would occur sooner and be more rapid than currently envisioned.”
Interest rates have been held at close to zero since the financial crisis in 2008, and since then, positive economic indicators have led to concern over interest rate increases. Government officials were not predicting an unemployment rate below 6% until 2015, but in June, it was reported that the jobless number was down to 6.1% from 7.5% in 2013. In spite of fewer unemployed, wages still remain stagnant, which is one reason Janet Yellen added there was still “significant slack” in the economic recovery and warned against declaring a “false dawn.” Even if the economic recovery continues, the consensus is that interest rate increases will be gradual; officials expect the rate to rise by 1% by the end of next year.
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Many on Wall Street reacted with criticism over the Fed Chief’s expressed concerns over the investors favoring high-risk assets to offset low interest rates, particularly speculative stocks in the biotech and social media sector and junk bonds. Yellen is concerned that this could create financial bubbles, given that the valuations of many small-cap stocks are “stretched.”
Jim Cramer, host of CNBC’s Mad Money, criticized Janet Yellen for making a “lame attempt” at addressing inflation concerns and for declaring certain social media stocks and biotechs overvalued, when success stories like Facebook and Pharmasset in the past have transcended valuation fears. He added that if the Fed is concerned with a bubble in these stocks, it should consider raising margin requirements as a “responsible” strategy.
The tech-heavy Nasdaq fell 5% after Janet Yellen’s testimony. However, bond index funds showed only a slight drop, with Bloomberg’s Active High-Yield U.S. Corporate Bond Index dropping only 0.07 percent. Nizam Idris, head of strategy for fixed income and currencies at Macquerie told CNBC he is not concerned; “I wouldn’t be too negative on high-yield bonds compared to the stocks, ” he said. “Stocks need to be supported by strong profit numbers. The income statement needs to be strong. Bonds need to be supported by a strong balance sheet. Right now, most corporates have strong balance sheets, but weak income statements, indicating bonds have more fundamental support.”
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