Yellen Confirmation, Not A Great Start

When it was announced Larry Summers was not going to be the nominee for the Federal Reserve Chair, I was both relieved and vindicated (I maintained that Summers could not make it through confirmation and was laughed at by my bond trader/manager friends). It was not without a bit of glee that Janet Yellen’s name jumped to the top of the list, this country needs more women in leadership and I think Yellen is very intelligent and capable. With that said, I also felt a tinge of “uh oh” as it’s no secret Yellen is as dovish if not more than current Fed Chair Ben Bernanke…who I’ve not been kind to in this blog over the years.

Yellen had her confirmation hearings last week and though I have not read the transcripts, if the Wall Street Journal can be believed I think my frustration with the Federal Reserve will continue.

On whether stocks are in a bubble the Wall Street Journal reported:

“Stock prices have risen pretty robustly,” she told lawmakers Thursday. But looking at several valuation measures — she specifically cited equity-risk premiums — she said: “you would not see stock prices in territory that suggest…bubble-like conditions.”

I understand that one of the goals of a confirmation hearing is to say the right things to get through it while also not  crashing the stock and bond markets…in this respect Yellen proved herself. But for all the talk about Yellen’s academic genius, I would have expected a more balanced answer. Surely there are measures that suggest valuations are outside the norm and maybe even in bubble territory such as Shiller’s CAPE, Tobin’s Q and Warren Buffet’s favorite measure of equity valuation. The meteoric rise of the stock market since March of 2009 with few pullbacks is another piece of evidence that perhaps stocks have valuation issues. Even if the measures Yellen prefers do not scream “bubble” an academic should cite all the evidence and make a balanced argument, such as “the evidence is mixed (cite the evidence), but our current view is that stocks, while currently at historic highs are not outside of our expectations.” Ambiguous as the statement is, it’s certainly better than than the above quote.

But it gets worse.

When asked specifically whether there is a federal role to support the stock market, Ms. Yellen provided a one-word answer: “No.”

I believe the Federal Reserve has two views of the economy, their view and the view they reveal to the public and Yellen’s “No” answer is another piece of evidence supporting that view. Anyone who doesn’t believe that the Fed doesn’t believe they have a role in supporting the stock market is ignoring nearly three decades of the Fed responding to the whims of the stock market.

But Yellen goes for the hat trick, with a double whammy.

“At this stage, I don’t see risks to financial stability” from current policies, she says, while noting limited evidence of “reach for yield” among investors or a buildup of leverage.

We actually have experience in this country with a Federal Reserve keeping interest rates too low for too long and now we’ve had a Zero Interest Rate Policy and massive bond buying (including unprecedented Agency bond buying) for several years with no end in sight. We also have a banking system that is more powerful than before the crisis.  There are certainly risks to financial stability due directly to Fed policies. This statement is outside of reality and bizarre to me as I’m almost positive the phrase “the potential benefits outweigh the risks” is a common phrase at the Fed these days. But to say there is limited evidence of a “reach for yield” is completely outside of all the evidence. I see a “reach for yield” everywhere. Anything with a yield attached to it gets bid up and any hint of a spread gets bought quickly. Investors, pensions funds and insurance companies are starving for yield and certainly reaching.

Yellen’s statements defy any sort of reality.

I intend to read the transcripts to see if there is more context than the Journal reported, but if not, all I can say is that I’m disappointed, but not surprised. I think the Federal Reserve needs strong and honest leadership, but more the type you’d get from Elizabeth Warren than Janet Yellen.

Yellen is going to inherit a very complex situation (one in which she had a big hand in shaping), my hope is that this confirmation hearing is just the performance needed to get the job and that the real Yellen is a little more pragmatic.

Scott Dauenhauer CFP, MSFP, AIF


4 thoughts on “Yellen Confirmation, Not A Great Start”

  1. I agree with you that there are risks and there will always be risks. Sure there is a reach for yield everywhere but there is also 2-3 trillion in MM accounts–that’s not reaching for yield. I agree with her that this is no bubble. There will always be busts and booms, this time is no different only its the fed stimulating the economy. Before it was internet in the 90s, defense and the beginning of deficit spending in the 80s that continues today (with a pause in the late 90s), 70s was no stimulus going on, space race in the 60s, more defense spending in the 50s, WWII in the 40s, etc. There was always a stimulus sometime to create a growing economy. The only time it was not government money was the 90s when we actually had a surplus.

    1. Steve,

      Thanks for your comments. I agree there will always be risk, however risk is not rewarded just for taking it – you must expect an adequate reward before accepting risk. You’ll notice that I didn’t say we were in a bubble, but that an academic cites the evidence to support their position and there is plenty of evidence for over-valuation in markets (regardless of your view or outlook) and I expect a more balanced response. The current “boom” is based more on Fed perception than reality. Federal Reserve policies are supposed to help lessen the affects of the boom bust cycle, not exasperate them. The 90’s boom ended when the government began running surpluses, not the other way around.

      Regardless, a Fed Chair that Wall Street loves is in my opinion dangerous.

  2. I get the feeling from you and many astute observers that investors are not going to be rewarding for the risk they are taking going forward. Bogle and others have said for several years now that returns going forward will be lower. Its hard to make that claim now when in this last year stock market returns look like the late 90s! I think is based on narrow economic activity, not from the usual suspects like spending.
    Because of the shrinking of the middle class, spending will never reach what it had in the last 30 years when everybody public and private were borrowing and spending. Those days are over.
    When people have 2-3 trillion in MM, spending will be down because little or no interest payments are generated for us older folks in retirement. In our personal account, we should be getting tens of thousands in interest only just from our fixed accounts, instead we are earning next to nothing by comparison because of low interest rates.

    1. Steve,

      I believe there is a significant amount of evidence to support the view that returns on most assets will be low over the coming 7 – 10 years. With that said the great philosopher Yoda once said “Hard to predict, the Future is.” Government deficits fed record profit margins and now that those have been cut in half, the difference must come from somewhere and it’s not clear consumer spending can keep up (at least for how long). This is not to say that I am not suffering from “confirmation bias,” of course history has not been kind to these valuation levels – so either “this time it’s different” or asset prices will stagnate or fall from their current levels. As you point out, the current low level of interest is hitting pocketbooks and forcing people up the yield curve or forcing them to spend principal. Those 0% money market accounts might make perfect sense in a deflationary environment, but we are still in the 2% range – so, it hurts. My overarching point is that caution is needed and that risk is not rewarded just because it is taken (completely ignoring behavioral aspects).

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