The Fed chair-elect wants to see a sustained recovery, writes Glenda Kwek.
The US sharemarket is not in a bubble despite rising to record highs this year, the vice chair of the Federal Reserve Janet Yellen said as she flagged a continuation of the central bank's unprecedented bond-buying program.
Yellen said stock prices had enjoyed a "pretty robust" rise, but were not exhibiting bubble-like conditions according to traditional valuation measures. The vice chair has been nominated by US President Barack Obama to be the next chair of the central bank, and spoke at her confirmation hearing with the US Senate's banking committee on Friday.
She told the committee she would continue to support the $US85-billion-a-month ($91.5 billion) bond buying program put in place by current Fed chairman Ben Bernanke until the US economy made a sustained recovery, but did not outline when she might start to wind back the stimulus.
The S&P500 rose to new highs on the back of her comments, which were interpreted as dovish. The US stockmarket has soared 25.5 per cent this year, after rising 13.4 per cent in 2012.
The Australian market and its Asian counterparts also rallied on Friday.
Yellen said she did not see any evidence of bubbles in major sectors of the US economy, adding that the Fed was closely monitoring asset prices, "whether it is house prices or equity prices or farmland prices, to try to see if there is evidence of price misalignments that are developing".
"By and large, I would say that I don't see evidence at this point in major sectors of asset price misalignments, at least of a level that would threat financial stability," she said.
She did not rule out using monetary policy to tackle asset bubbles, but described it as a "blunt tool", adding that the Fed also had other micro and macroprudential tools at its disposal.
The Republican senator for Nebraska, Mike Johanns, said at the hearing that he was seeing asset bubbles in real estate.
"I think the economy has gotten used to the sugar you put out there and I just worry that we are on a sugar high," he told Yellen.
"We are now starting to see real estate bidding wars, just like the old days. [If the Fed started to wind back its bond buying program] I think we would see how big those asset bubbles are." Johanns echoed fears by observers that the sharemarket would be badly hit when the Fed starts to trim the bond-buying program, pointing to jitters in the market when Bernanke raised the prospect of tapering this year.
Other observers have argued that given the market's recent strong rises, it was due for a correction, which Wingate Asset Management chief investment officer Chad Padowitz said could happen in the next six to 12 months.
"I think the momentum does feel too much too soon," Padowitz said of the rise in US and European stocks.
"There's definitely an over-extension of future expectations relative to the risks that are there. We think the risks are not that the market is exceptionally overvalued, but that the market is not pricing any risks in the downside."
Padowitz said the market was not yet in bubble territory as other measures - such as a lack of a relation between earnings and share prices and significant euphoria - had not occurred. But he said the market could be in for a correction of at most 15 per cent within the next year.
"The dividend yield on equities now is in many cases higher than you can get on cash and fixed income," Padowitz said.
"So if shares were to drop somewhat, there's a lot of money sitting on the sidelines in many places that might see that as an attractive entry point. They've may be thinking they've missed the boat this time round. So that would provide significant support once you get to some initial drop."
Platypus Asset Management chief investment officer Don Williams said financial markets were prepared for tapering, and did not expect investors to rush out of equities.
"We would argue that if the economic data is reasonable and improving, the Fed can start to taper and it will have a minimal impact on the market," Williams said.
"Investors will focus more on the improvement in the economy and what that means for earnings than the fact that some of the monetary stimulus is being withdrawn."