"The Committee recognizes that low interest rates may provide incentives for some investors to "reach for yield," and those actions could increase vulnerabilities in the financial system to adverse events. While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk."
What we find this interesting is how Yellen separated out high-yield bonds as overvalued while describing stocks as in line with historical norms. Over the last five years, the S&P 500 and the spread between high yield bonds and US Treasuries have moved largely in lock-step, with an 82% correlation.
In the last year, the assets have exhibited a 95% correlation. Interestingly, in June, high yield spreads started to back up while the equity market powered ahead. It feels like we have seen this sequence before...
In June 2007, high yield spreads reached a maximum low relative to US Treasuries of 2.48% and stocks peaked four months later only 1% higher. Over the following 18 months, high yield spreads backed up to 20% while stocks fell from 1561 to 666.