Warning: Janet Yellen Reveals Her Favorite Momentum Trades

Fed chief and rouge trader Janet Yellen must have lost some cash on a wayward Facebook trade last week, because she’s not too happy with the market’s beloved momentum stocks…

Here’s the dirt, straight from the Chair’s mouth:

Valuation metrics in some sectors do appear substantially stretched — particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.

She’s so nice that she had to say it twice, notes Business Insider. Here she goes again:

Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms.

But wait—don’t sell everything! Yellen said she isn’t concerned with valuation issues in the broad market. So investors aren’t “excessively optimistic regarding equities” just yet.

Thanks, Janet.

At just seven months into the job, Yellen already has her very own irrational exuberance moment for the scrapbook. And from the looks of the markets yesterday, traders were paying close attention—at least initially.

If you weren’t looking too closely, yesterday was another mundane summer trading day. The S&P finished down just about 4 points. But under the surface of the big index, there was plenty of telling action.

Small-caps took a big hit. The Russell 2000 fell my more than 1%. The iShares Biotech ETF shed more than 2% on the day. Most social media stocks on my radar finished in the red (though some fought to make up their largest losses late in the afternoon).

Russell 2000 vs. Biotech iShares, July 15, 2014

So just to clarify, the Fed wants you to keep buying stocks. Just don’t buy those pesky speculative names in the frothiest sectors. Got it?

Oh, and I’m certain that everyone was trading those social media stocks because they were good values, right? It had nothing to do with momentum—or the fact that high-profile IPOs from these sectors have been all over the news for the past couple or years…

“It’s even more rich in light of a speech she gave earlier this month in which she said the Fed no longer much cares about asset bubbles and it would be a bad idea to raise interest rates to fight them,” comments our own Dave Gonigam over at the 5 Min. Forecast. “Asset bubbles, she averred, only become a problem if they threaten to take down the economy along with the assets.”

So what the heck are you supposed to do in light of these new comments?

Let’s check the history books. That’s where you’ll find the Fed’s not-so-stellar track record when it comes to timing these potential bubbles. Remember, Greenspan delivered his “irrational exuberance” speech in late 1996. The speech happened after the Nasdaq had jumped 74% in two years and hadn’t seen a 20% decline in more than six years, MarketWatch reminds us.

Of course, we know what happened next. The Nasdaq dropped initially after Greenspan’s comments, only to soar to new highs and climb more than 50% through mid-1998.

The lesson?

Keep a close eye on the trends — not market comments from the Fed. Your portfolio will thank you.

Regards,

Greg Guenthner
for The Daily Reckoning

P.S. The most lucrative trends are out there right now, making a handful of savvy investors a ton of money… while you watch from the sidelines. Don’t you think it’s time you get in the game and start raking in the gains yourself? If so, you’ll want to catch tomorrow’s issue of The Rude Awakening — an email edition of my full research and analysis that comes straight to your inbox every morning, right around the opening bell. And it’s completely FREE!

In addition, your subscription secures you exclusive access to trends I reserve just for my email edition readers, including regular opportunities for you to discover some incredibly lucrative stock picks. It’s one of the fastest, simplest ways you can get a leg up on the markets. Sign up for FREE, right here, before you read anything else today.

The Daily Reckoning