Irrational Exuberance 3.0: Fed Again Warns Of A Build Up In "Valuation Pressures"
The last time Janet Yellen, Series 7, 63 certified, warned of asset bubbles, aka the Fed’s “Irrational Exuberance 2.0” moment, was back in July 2014, when the smallest of utterances led to a selling avalanche in biotech and social media stocks. This is what the Fed said back then:
“Nevertheless, 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. Moreover, implied volatility for the overall S&P 500 index, as calculated from option prices, has declined in recent months to low levels last recorded in the mid-1990s and mid-2000s, reflecting improved market sentiment and, perhaps, the influence of “reach for yield” behavior by some investors….”
… signs of risk-taking have increased in some asset classes. Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms. Beyond equities, risk spreads for corporate bonds have narrowed and yields have reached all-time lows. Issuance of speculative-grade corporate bonds and leveraged loans has been very robust, and underwriting standards have loosened. For example, average debt-to-earnings multiples have risen, and the share rated B or below has moved up further for leveraged loans.
It’s time for the Fed’s shot across the bow, this time explicitly warning of the “potential risks to financial stability.” From the just released minutes.
Relatively high levels of capital and liquidity in the banking sector, moderate levels of maturity transformation in the financial sector, and a relatively subdued pace of borrowing by the nonfinancial sector continued to be seen as important factors limiting the vulnerability of the financial system to adverse shocks. However, the staff report noted valuation pressures in some asset markets. Such pressures were most notable in corporate debt markets, despite some easing in recent months. In addition, valuation pressures appear to be building in the CRE sector, as indicated by rising prices and the easing in lending standards on CRE loans. Finally, the increased role of bond and loan mutual funds, in conjunction with other factors, may have increased the risk that liquidity pressures could emerge in related markets if investor appetite for such assets wanes. The effects on the largest banking firms of the sharp decline in oil prices and developments in foreign exchange markets appeared limited, although other institutions with more concentrated exposures could face strains if oil prices remain at current levels for a prolonged period.
It’s ok though: as the IMF previewed earlier today, asset managers may be responsible for the next bubble but it is only because of “rational bubble-riding” – you know, the kind that the Fed’s macroprudential policies will promptly spot and fix post haste.
As for the other institutions whose “concentrated oil exposures” will rock the boat, we – like the Fed – just can’t wait to find out who they are…
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Irrational Exuberance 3.0: Fed Again Warns Of A Build Up In "Valuation Pressures"
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