4 Stocks To Buy On Yellen's Valuation Warning

In her testimony before a Senate panel, Fed Chair Janet Yellen issued a warning about stocks being overvalued. This was in keeping with the views expressed by the central bank in its policy report submitted to Congress before the Fed Chair’s testimony.

This is not the first time that Yellen has weighed in on equities being overvalued. The Fed Chair had expressed similar concerns about biotech and social media stocks two years earlier. Given the state of the markets and economy, it may be a good idea to add value stocks to your portfolio at this time.

Fed, Yellen Sound Valuation Alarm

In her testimony before the Senate panel on Tuesday, Yellen said that valuations were a matter of concern because of investor pessimism about corporate earnings. In other words, stock prices are on a slippery slope because of the dismal expectations about corporate earnings.

The Fed Chair’s comments echoed similar fears expressed in the central bank’s monetary policy report. In the report the Fed said forward price to earnings were at significantly higher levels compared to their medians over the last 30 years. Market watchers believe that the central bank has clearly stated that valuations of financial assets had increased because of the low interest rate environment.

Were Similar Concerns Justified in the Past?

Concerns about stocks being overvalued were nearly identical to those expressed two years earlier, though they centered on specific sectors. The Fed’s monetary policy report issued in Jul 2014 had sparked concerns about “substantially stretched valuations” in Internet and biotech stocks.

At that time, Fed Chair Yellen had stressed that the Federal Reserve doesn’t have a target for equity values; instead the central bank tries to figure out if valuations are outside historical norms. But what actually happened in the space of these two years?

During the period between Jul 15, 2014 and Jun 22, 2016, the Global X Social Media Index ETF gained 8.9% while the iShares NASDAQ Biotechnology ETF increased 2.5%. During the same period, the S&P 500 index advanced 5.6%. This means that the Fed Chair was correct about biotech stocks, since they underperformed the broader market.

However, a broader market decline did not follow and social media stocks actually gained over time. But this doesn’t mean Yellen got it wrong. For instance, 20 years ago, the redoubtable Alan Greenspan had wondered if the market was suffering from “irrational exuberance.”

After three years, the Nasdaq lost nearly 78% of its value. Given the multiple concerns the economy is combating now, a slide could come much sooner. It is worth remembering that Yellen has expressed concerns about weak business investment and below target inflation levels.

Our Choices

According to Thomson Reuters DataStream, the forward price-to-earnings ratio is currently at 16.47. In comparison, the median value for the last three decades is 14.86. If one takes the Fed’s and Yellen’s comments into consideration, picking stocks with lower forward price to earnings would make a lot of sense.

At the same time, it may be a good idea to consider options with good PEG ratios. Our selection is also backed by a good Zacks Value Score and Zacks Rank.

We narrowed down our choices with the help of our new Zacks Investment Research

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Written By: Zacks Investment Research