Memo To Yellen: Stocks At 3rd Highest Shiller PE Ever---Not At "Historical Norms"

By Pater Tenebrarum at Acting Man blog

Ms. Yellen has inter alia shared her insights about financial markets with the Senate Banking Committee – while wearing her bubbly dress, no less!  According to her, there may be a “risk of bubbles” in leveraged loans and low grade debt – to which we say, it is way too late to worry about whether there “may” be such a risk. That horse has left the barn long ago. We have the biggest bubble in low grade debt ever, and central banks are 100% responsible for it.

Interestingly, she thinks that stocks at the third highest CAPE in all of history are just fine, valuation-wise (CAPE or Shiller P/E at 25,5 currently, approximately at the 92nd percentile of the 1602 data points in this series according to Doug Short). Note here that there are some measures by which stocks are actually valued at the second highest level since the 2000 mania peak (e.g. price/revenues).

Our guess? She is probably consulting the long-discredited “Fed model” when she is trying to divine whether stocks are overvalued. 

Bloomberg reports:

“ Federal Reserve Chair Janet Yellen warned she sees signs of asset price bubbles forming in some markets such as those for leveraged loans and lower-rated corporate debt, while indicating stocks aren’t overvalued.

“We’re seeing a deterioration in lending standards, and we are attentive to risks that can develop in this environment” of low interest rates, Yellen said today in semi-annual testimony to the Senate Banking Committee.

With stocks hovering near record highs, Yellen signaled she isn’t worried about frothy markets broadly, saying in prepared remarks that equities, real estate and corporate bond values are in line with historical norms. The Fed needs to hold its benchmark policy rate near zero, where it’s been since December 2008, until the labor market improves and inflation accelerates, she reiterated.”



Ms. Yellen at the senate hearing – wearing a dress with lots of small bubbles on it

(Photo credit: Andrew Harrer / Bloomberg)

 As noted above, those “historical norms” have happened only very few times in history, and they were generally visible at major bubble peaks. At least Ms. Yellen acknowledged that ultra-low interest rates are actually fomenting bubbles (or rather “can be conducive” to doing so, as if it didn't happen every time) but that was followed by a real knee-slapper – better put the coffee down dear readers:

“Responding to questions from the committee, Yellen said low interest rates can be conducive to the formation of bubbles, and that the Fed was watching carefully for signs of such increased risk-taking. She cautioned that the central bank will not “be able to catch every asset bubble.”


Say what? When has the Fed ever “caught” a bubble or even recognized one? Has it ever done anything about bubble conditions? The Fed is causing these bubbles! Anyway, as we have mentioned previously, Ms. Yellen is going to nip any of those possible “maybe” bubbles in the bud by flattening them with the macro-prudential steamroller if need be (the steamroller is unwrapped if the hard macro-prudential stare should prove insufficient).


Merill High Yield Master IndexMerrill High Yield Master Index, effective yield. Maybe it should be renamed the “Low Yield Master Index” (with as much risk as if it were high yield).  If you're looking to buy something that offers zero margin for error, this is it – via Saint Louis Federal Reserve Research, click to enlarge.


The sand pile is still growing – bubbles are a bit like growing sand piles, in that they look perfectly stable until a single grain too many is added to them – then comes the avalanche, seemingly out of the blue. Eventually, there will be a lot of wailing and gnashing of teeth again, and we will be told that “no-one could have seen it coming”.

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