Fisher says quantitative easing leads to “irrational exuberance”



The Dallas Fed’s Richard Fisher at the Asia Society

Fisher spoke at the Asia Society in Hong Kong on Friday, April 4, about “forward guidance” in monetary policy, which he described as “the subject du jour of central bankers.” It recently became a focus of discussion again in the U.S. after the Fed’s March FOMC meeting, when the Fed decided to go with “qualitative” rather than “quantitative” guidance regarding its future monetary policy statements. During his address, Fisher also spoke about the fallout from quantitative easing (or QE), both favorable and unfavorable. In the last article of this series, we discussed the favorable outcomes Fisher described. This article considers some of the unfavorable outcomes he outlined.

Part 4

Richard Fisher’s sounds a note of caution

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In his address, Fisher said, “The former funds manager in me sees these as yellow lights. The central banker in me is reminded of the mandate to safeguard financial stability. As I said recently in a speech in Mexico, we must watch these developments carefully lest we become responsible for raising the ghost of irrational exuberance.”

  1. Fisher said that at ~26, the inflation-adjusted Shiller PE ratio was in the highest decile of reported values since 1981, as the S&P 500 Index (SPY) reached another record high. Last week, the S&P 500 Index (SPY) increased by 13.18 points, or 0.7%, to 1,885.52, beating its previous record reached on March 7, 2014. The index also reached an all-time intraday high of 1,885.84.
  2. Fisher also said the market cap of the US stock market as a percentage of the country’s economic output has more than doubled, to 145%, over the last five years, which is also the highest level since the March 2000 record.
  3. Margin debt has been setting historic highs for several months. As per data released by the NYSE, margin debt stood at ~$466 billion in March.
  4. We’re seeing increasing trend of covenant-lite loans due to money center banks advancing sums on imprudent terms.
  5. Declining junk-bond (JNK) yields are nearing historic lows at less than 5.5%. The SPDR Barclays Capital High Yield Bond ETF (JNK) and the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) are two ETFs investing in high yield debt.

However, markets appear to be considering the risks inherent in high-yield bond ETFs. After clocking total returns of more than 25% over the past three years, the short interest ratio for JNK increased to 7.051x on February 28, 2014—the highest in the ETF’s history, since its inception in November 2007—while the short interest ratio for HYG increased to 7.746x on February 28, 2014, the highest level since September 14, 2007. To read more about the short-interest spike for JNK and HYG, read the Market Realist series Will investors prefer investment grade over high yield in 2014?

The S&P continues a bull run into its sixth year, posting a 16-year record in 2013

Last year, the S&P 500 Index posted its best performance since 1997, returning over 32% (SPY). The biggest gainers in the S&P 500 Index (SPY) in 2013 were video subscription company Netflix (NFLX) and semi-conductor maker Micron Tech. (MU)—up 297% and 241%, respectively. The biggest losers in 2013 were Newmont Mining (NEM) and Cliffs Natural (CLF), which fell ~51% and ~31%, respectively.

To learn about what Fisher had to say about the pace of tapering, please read on to Part 5 of this series.


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