By Kevin Cirilli and Julian Hattem - 07/15/14 09:17 PM EDT
With just two words — “substantially stretched” — Federal Reserve Chairwoman Janet Yellen sent social media stocks tumbling on Tuesday and stirred rampant talk of a “bubble” in the market.
The assessment, a part of the central bank’s annual report to Congress, was couched in technical language, warning that “risk-taking” in the social media and biotechnology sectors appeared to have increased, unlike in other industries where stock valuations have kept in line with historical averages.
The message heard on Wall Street was simpler: sell, sell, sell.
Silicon Valley supporters pushed back hard on Yellen’s “substantially stretched” evaluation as tech stock began to dive.
“We are not!” said John Melloy, chief executive of Twitter stock analysis firm StockTwits, on Twitter.
Julie Samuels, executive director of the startup advocacy group Engine, also disputed Yellen’s report.
“Not only is the Fed wrong, but their comments are misplaced because we should be incentivizing these new companies to grow,” Samuels said. “We should be incentivizing people to invest in those companies so they do create jobs.”
Shares of Facebook and Twitter closed more than 1 percent down in trading for the day, while Yahoo, LinkedIn and Google all posted more modest losses.
Yellen’s market-rattling assessment came during testimony to the Senate Banking Committee, where she gave her regularly scheduled update on the Fed’s economic outlook for the year.
Senators did not press the Fed chief about the stocks, instead peppering her with questions about the job market and monetary policy.
But Yellen is likely to be pressed to explain her take on the stock market Wednesday, when she will head to the other side of the Capitol to testify before the House Financial Services Committee.
The damage from Yellen’s report to the market could have been far greater, but the Fed chief was careful to say that she thinks the overall stock market — which has been notching weeks of steady gains — is on firm ground.
Broadly speaking, stocks are “generally at levels not far above their historical averages, suggesting that, in aggregate, investors are not excessively optimistic regarding equities,” Yellen said in the report.
Jim O’Sullivan, chief economist for High Frequency Economics, said the Fed is sending a clear signal that the gains in the stock market “as a whole are quite reasonable and justified.”
“The market has been quite rational and not overly exuberant,” O’Sullivan said.
“However, there may be some exceptions on a sector basis, most notably in the social media sphere — without naming names, of course,” he said.
Yellen didn’t need to name names.
In recent months, tech firms have been breaking the bank with eye-popping acquisitions that often seem aimed at finding the next big thing.
Just this year, Facebook paid $19 billion for messaging service WhatsApp and $2 billion for the virtual reality headset manufacturer Oculus VR.
Apple paid $3 billion for Beats, the streaming music and headphones company built on the star power of Dr. Dre.
Google dropped $3.2 billion for Nest Labs, which makes “smart” products for the home.
The swift reaction among traders to Yellen’s report illustrates the enormous power she holds over the attitudes and decisions of investors.
“[Tuesday’s] market reaction among social media stocks illustrates just how powerful are the Fed’s actions in picking winners and losers in our economy,” said Mark Calabria, director of financial regulation at libertarian-leaning Cato Institute.
Any talk of overvalued stock was bound to rattle some nerves, given that the major indexes have been soaring to record highs, with the Dow Jones industrial average crossing 17,000 this spring.
Yellen’s remarks echoed comments from Fed Governor Daniel Tarullo earlier this year, when he said that smaller tech firms’ “valuations do appear stretched.”
Some equated Yellen’s remarks to when then-Fed Chairman Alan Greenspan warned of a stock market bubble in a December 1996 speech, when he famously questioned the market’s “irrational exuberance.”
Stuart Hoffman, chief economist at PNC Financial Services Group, estimated the storm from Yellen’s report will quickly pass.
“Social media stocks are down today, but not likely to move much lower and stay down for long,” Hoffman predicted.