(Adds graphic, additional details on valuation)
By Rodrigo Campos and Caroline Valetkevitch
July 15 The Federal Reserve on Tuesday voiced
concern about stretched valuations in certain corners of the
U.S. markets, including small cap, biotechnology and social
media stocks, as well as the leveraged loan market.
The unusual comments from the Fed's monetary policy report -
the first time in 14 years that the Fed has commented
specifically on valuation of a particular equity sector - that
accompanied Fed Chair Janet Yellen's semi-annual testimony to
Congress, hit stocks in riskier sectors of the market.
Yellen said in remarks to the Senate Banking Committee that
valuations across equity markets remain generally in line with
long-term averages, but the Fed's report said the forward
price-to-earnings multiples for smaller companies and those in
the biotechnology and social media sectors appear "high relative
to historical norms."
Well-known names such as Facebook, LinkedIn and Yelp slipped
after the news. Shares of Yelp Inc were among the
hardest hit, falling 2.8 percent to $69.14 a share, and the
Nasdaq Biotech Index also fell, losing 1.6 percent.
"It's very unusual for the Fed chairman to take a micro view
of a specific industry group. Usually the comments are very top
level. So I think the Fed is a little more in tune with what has
been bothering the market. My thought is it's late, but not too
late in terms of recognition," said Fred Dickson, chief market
strategist at D.A. Davidson & Co. in Lake Oswego, Oregon.
Last week the equity market weakened, with notable declines
in small-cap names. The Russell 2000 has lost 4.6 percent
in the last seven trading days, while the Nasdaq Biotech index
is off by 4.8 percent.
Throughout 2013, social media and biotechnology shares were
among the market's most popular names, posting massive gains as
investors, particularly hedge funds, piled in. Meanwhile
short-sellers who saw the stocks as overvalued were forced to
reverse those bets as they lost money. The Global X Social Media
ETF, which includes Facebook and LinkedIn among its
holdings, rose 64 percent in 2013.
The gains occurred even as these stocks sport lofty
price-to-earnings ratios that far surpass valuations of the
broader index. While the benchmark Standard & Poor's 500 stock
index has a forward P/E of about 15.5, Facebook's forward P/E is
about 55 and Twitter is at 145.
Hedge funds were caught this year, when those stocks slumped
in late February in a selloff that continued for several weeks.
The stocks rebounded in June, but most have failed to attain
earlier heights. The SOCL exchange-traded fund is down 11.4
percent in 2014.
"These are the sub-industries that have caused a lot of long
time stock watchers to scratch their heads," said Kim Forrest,
senior equity research analyst, Fort Pitt Capital Group in
"I'd say she'd like to deflate these bubbles with a little
bit of stock talk."
Also in the report, the Fed notes that issuance of
"speculative-grade corporate bonds and leveraged loans has been
very robust, and underwriting standards have loosened," with
lower-rated issuers sporting higher debt-to-equity ratios.
The last mention of specific equity sectors appears in a Fed
monetary policy report in July 2000, when it says that "growing
unease about the lofty valuations reached by technology shares
and rising default rates in the corporate sector may have given
some investors a better appreciation of the risks of holding
stocks in general."
Art Hogan, chief market strategist at Wunderlich Securities
in New York, said the comments also recall former Fed Chairman
Alan Greenspan's statement in 1996 during a speech, when he
asked whether "irrational exuberance has unduly escalated asset
values," which sparked a brief selloff in stocks.
"Am I surprised? Absolutely! It's off the script," Hogan
"It's not what we're used to and it's certainly not
something that we ever got from (former Fed Chair Ben)
(Reporting By Dan Burns, Rodrigo Campos, Herb Lash and Caroline
Valetkevitch; Writing by David Gaffen; Editing by Chizu