Incomep, get ready for the turbulence tomorrow.
Thu, 14 Oct 1999, 10:25pm EDT
Greenspan Says High Stock Prices Are a Risk; U.S.
Stock Index Futures Drop
By Bill Arthur
Greenspan Says Stock Gains Put Investors at Risk (Update3)
(Adds analysts' comments, latest markets; for full text of
speech: NI FED CRL )
Washington, Oct. 14 (Bloomberg) -- Federal Reserve Chairman
Alan Greenspan said surging stock prices have increased risks for
investors and lenders, and financial institutions should boost
their reserves to weather market panics.
Losses will ''inevitably emerge from time to time when
investors suffer a loss of confidence,'' as they did a year ago
after Russia defaulted on its bank debt, Greenspan said in an
evening speech to a conference sponsored by the Office of the
Comptroller of the Currency.
While Greenspan didn't directly address the level of U.S.
stocks, Standard and Poor's 500 stock index futures slumped after
the Fed chairman's text was released at 7 p.m. in Washington. The
index fell more than 10 points in trading on the Chicago
Mercantile Exchange. In Tokyo after Greenspan spoke, the dollar
fell to 106.68 yen from 107.36 yen at the prior New York close.
''He's not trying to kill the economy. He's just trying to
take a little bit of the froth out of the markets,'' said Karl
Mills, chief strategist, Jurika & Voyles Inc., an investment firm
in Oakland, California.
This isn't the first time Greenspan raised questions about
stocks. On Dec. 5, 1996, he said central bankers must guard
against ''irrational exuberance'' in markets. That comment, also
in an evening speech, sent the Dow Jones Industrial Average
skidding as much as 2.3 percent at the start of trading the next
morning. By the end of the day, the index recovered about two-
thirds of the decline.
The Dow index is also more than 60 percent higher today than
it was when Greenspan issued that 1996 warning.
Another Warning
Now, Greenspan has issued what sounds like another warning,
said Mark Vitner, an economist with First Union Capital Markets
Group in Charlotte.
''The Fed has pushed interest rates up twice'' since June
without effect on spending, Vitner said. Greenspan could be
trying to ''tighten credit through moral suasion'' on banks,
saying, ''Hey, watch your lending, and that will cool the economy
off quicker than anything else.''
''A lot of what the Fed has been trying to convey is that we
don't know the extent of the risk to the economy posed by the
stock market,'' Vitner said. ''We don't know what the risk is
that portfolios could take a shock, and we don't know how that
would ripple through the economy.''
Like Fire Insurance
Greenspan said he said ''the key question'' is whether the
recent decline in so-called equity premiums -- a measure of the
return investors are willing to accept for common stocks compared
to holding risk-free assets like Treasury securities -- is
permanent or temporary.
''If it proves temporary, portfolio risk managers could find
that they are underestimating the credit risk of individual loans
based on the market value of assets and overestimating the
benefits of portfolio diversification,'' he said.
As a consequence, Greenspan said banks and other financial
institutions must ''set aside somewhat higher contingency
resources -- reserves or capital'' to cover potential losses.
Maintaining such funds may seem like a less than optimal use
of money, but ''so do fire insurance premiums,'' Greenspan said.
The Standard & Poor's index of 500 stocks is also 263
percent higher than it was on the last trading day of 1989.
That's even after a decline of almost 10 percent in the index
since it set a record in July, shortly after the first of the
Fed's two quarter-point increases in the overnight bank loan
rate. The Fed policy-makers meet again Nov. 16.
The yield on the 30-year Treasury bond has also risen more
than a full percentage point since early February on concerns
that the Fed will need to continually raise interest rates to
slow the economy as a way of keeping inflation in check.
Inflation Fears
A government report tomorrow could intensify investor
concerns about inflation. It is expected to show that prices paid
to U.S. producers rose in September for a third straight month,
pushed up by higher oil and tobacco costs.
Those numbers 'could have a dampening or compounding
influence'' after Greenspan's comments, which will obviously
produce a market reaction, said Barry Hyman, chief market
strategist at Ehrenkrantz King Nussbaum Inc. ''This comment does
indicate that interest rates are probably heading higher at the
November meeting, and that's troublesome for equities.''
''I expect the Dow to fall below 10,000 today (Friday),''
said Takashi Okura, head of foreign exchange at Banc One Corp. in
Tokyo. ''I don't want to hold dollars today as the dollar could
fall below 106 yen'' during New York trading.
Even after the recent decline in stocks, investors still
must pay the equivalent of 30 times the earnings of the average
S&P 500 stock today. While that's down from this decade's high
p/e of 35 in April, it's well above the average of 21.6 for all
of the 1990s.
''Cash and bonds are a far more attractive place to be than
equities and Greenspan is quite right to question markets
accordingly,'' said Michael Wood, who helps manage A$9 billion
(US$5.9 million) in Australian investments at Salomon Smith
Barney Asset Management Australia Ltd. ''The equity risk premium
is way too narrow and does not reward investors for the risk in
equities above and beyond the bond markets.''
Logical Reasons
Greenspan suggested there are logical reasons investors are
willing to pay so much for stocks. For one thing, the growing
wealth of information and the speed in which information is
gathered and distributed have ''reduced uncertainties'' and risk
of relying on equities.
''That equity premiums have generally declined during the
past decade is not in dispute,'' Greenspan said. ''What is at
issue is how much of the decline reflects new, irreversible
technologies, and what part is a consequence of a prolonged
business expansion without a significant period of adjustment.''
Greenspan said ''panic reactions in the market are
characterized by dramatic shifts in behavior that are intended to
minimize short-term losses.''
This happens time and time again throughout history, he
said. ''Whether Dutch tulip bulbs or Russian equities, the market
price patterns remain much the same,'' he said.
Central bankers are no more adept than investors at
predicting when panics set in, Greenspan said. ''Collapsing
confidence is generally described as a bursting bubble, an event
incontrovertibly evident only in retrospect,'' he said. ''To
anticipate a bubble about to burst requires the forecast of a
plunge in the prices of assets previously set by the judgments of
millions of investors, many of whom are highly knowledgeable
about the prospects for the specific investments that make up our
broad price indexes of stocks and other assets.''
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