NEW YORK (Reuters) - Fed Chair Janet Yellen may have surprised the markets this week by noting that valuations in some parts of the U.S. stock market look stretched but mutual fund managers mostly greeted her comments with a shrug.
Social media, small company and biotech stocks fell broadly Tuesday after the Federal Reserve noted that forward price to earnings multiples in those sectors appear “high relative to historical norms.” It was the first time in 14 years that the U.S. central bank had made specific comments on the valuations on a particular equity sector.
For mutual fund managers, however, it was added confirmation that the five-year-old bull market is showing its age. The benchmark Standard & Poor's 500 stock index .SPX has nearly tripled from its March 2009 lows, including a nearly 30 percent rally in 2013. The index, which for 2014 is up 6.9 percent year to date, now trades at a price-to-earnings ratio of approximately 15.6, above the 20-year historic average and signaling that low-priced stocks are harder to come by.
As a result, fund managers are holding fewer companies overall and making trades less frequently, according to a recent report by Nasdaq OMX Group. Yet while the Fed may be correct that some parts of the market are overheated, fund managers say that they are still finding pockets of attractively priced companies that undermine fears of a widespread bubble.
“You have to try to draw a distinction between a broad brush sector and the individual stocks inside of it,” said Eric Schoenstein, a co-manager of the $5.3 billion Jensen Quality Growth fund (JENSX.O).
Several fund managers echoed those sentiments. The notion that more speculative social media, biotech and small cap stocks now look pricey was a “statement of the obvious by Ms. Yellen,” said George Shipp, whose $1.1 billion Sterling Capital Special Opportunities fund (BOPIX.O) has logged the best performance among large-cap growth funds for the year to date.
Shipp has positions in Myriad Genetics Inc (MYGN.O), a biotech which develops tests that can assess a person’s risk of developing a disease, and Akamai Technologies Inc (AKAM.O), a company that essentially helps websites run faster, and is holding on to them because he sees the companies as “better established and lower risk for our shareholders,” he said. Myriad shares are up 83.5 percent this year, while Akamai has gained nearly 25 percent in 2014.
Not all fund managers welcomed the comments by the Fed on valuations, however. “Central bankers try to get granular in an effort to try to be more credible to market players. The problem is it invariably backfires,” said Greg Peters, senior investment officer of multi-sector funds at Prudential.
While stocks are somewhat pricey compared to historical levels, few fund managers voiced fears of a rerun of the late 1990s dot-com bubble. Margaret Patel, senior portfolio manager at Wells Capital Management in Boston, said she could see valuations continuing to rise as strong earnings and sales growth prospects drive social media and biotechnology stocks higher.
She said she hasn’t seen “anything that indicates that we’ve entered bubble territory, even in high-priced parts of the equity markets”.
Jay Welles, senior technology analyst at Manning & Napier Inc (MN.N), who advises funds like the $1.4 billion Manning & Napier Equity Series (EXEYX.O), said that not all social media stocks are overvalued.
“We’re still finding companies like Facebook and LinkedIn that fit both fundamental and valuation criteria,” he said. The fund held $14 million worth of Facebook Inc (FB.O) shares as of June 30, and $11 million worth of LinkedIn Corp LNKD.N shares as of the same date.
Yet the fund is not making a broad bet on the sector, he added.
“You really have to parse the sector and really do your homework. I think there are a lot of low-quality social networking stocks, and recent IPOs, that are overvalued,” he said. “There’s quite a bit of junk out there.”
Reporting by David Randall; Additional reporting by Ross Kerber in Boston and Sam Forgione and Jennifer Ablan in New York; Editing by James Dalgleish