Interesting article in Barrons by Abelson about bubbles (what are those?) and Greenspan:
interactive.wsj.com
June 21, 1999
Bubble Trouble
By Alan Abelson
The child is father to the man.
William Wordsworth had it absolutely right. Consider, for example, the case of
Alan Greenspan, the highly respected chairman of the Federal Reserve Board.
When Mr. Greenspan was a tyke, his mom, a wonderful lady but strict,
peremptorily denied her son intimate contact with bubble gum. That made Alan
a much tidier little fellow and much more becoming to behold. But it also was to
have grave and, for the nation, momentous consequence years later.
For absent the normal childhood experience of chewing bubble gum, Mr.
Greenspan, after successfully negotiating the trying passage of adolescence,
reached adulthood bereft of any knowledge of bubbles.
This has proved both a blessing and an impediment. A blessing in that he has
not rushed to prick bubbles where none existed and thus has spared the country,
the economy and investors the pain of unnecessary credit tightenings. An
impediment in that he can't see a bubble when it's resting on the tip of his nose.
He all but confessed to this visual limitation in his testimony last Thursday
before Congress. Alluding to the great bull market of the 'Nineties, he sighed
that it was "difficult to assess" whether "an unstable bubble" had "developed in
its wake."
We don't want to fuss over verbal nuance or try to deconstruct Mr.
Greenspan's unfailingly subtle syntax. But that phrase "unstable bubble" rather
underscores his unfamiliarity with the phenomenon by implying there's such a
thing as a "stable bubble."
Besides, he insisted, most asset bubbles can be perceived only "after the fact."
To spot a bubble in advance "requires a judgment that hundreds of thousands of
informed investors have it all wrong."
Well, yes. The chairman, however, seemingly finds such a possibility
inconceivable. Yet, in virtually the same breath -- certainly the same testimony
-- he contends it's perfectly okay to make a pre-emptive strike against future
inflationary pressures in the economy. In other words, it's okay to make a
judgment that thousands of informed companies and millions of informed
consumers have it all wrong.
Why is it too much of a stretch to assume that the price of stocks has reached
inflated levels but not too much of a stretch to assume that the price of products
and labor may reach inflated levels? Beats us -- better ask Mr. Greenspan.
But perhaps you needn't bother -- he has already more or less supplied the
answer: Inflation in the economy that doesn't yet exist is easy to spot; a
financial-asset bubble that well may exist is too tough to spot.
Let us, then, and purely out of civic impulse, try to help repair the lacuna in Mr.
G's vision. Via a kind of financial Braille, perhaps we can provide him graphic
evidence of a bubble.
Behold that chart. It comes to us from Ed Yardeni, Deutsche Bank's shrewd
surveyor of the economy. What it shows is a model of stock-market valuation
that is based on the ratio of the S&P 500 Index to "fair value"; to determine fair
value, divide the consensus estimate for operating earnings of the S&P over the
next 12 months by the yield on the 10-year Treasury bond.
As you can see at a glance, by this measure, the market is grossly overvalued,
more so, indeed, than it was in 1987 before the crash. And such striking
overvaluation, we imagine Mr. Greenspan would agree, reasonably defines a
bubble. Moreover, it's a safe bet that he has a more than passing acquaintance
with the chart, since the model is the proud handiwork of the Fed.
Which may be why he pays it no mind.
But, we're happy to say, we can offer Mr. Greenspan confirmation of the
existence of a bubble from a source outside the beltway. Way outside --
Minneapolis, to be precise, where our old friend and renowned market watcher
Steve Leuthold hangs out.
In his most recent "Perception for the Professional" commentary, Steve updates
his aptly, if redundantly, entitled "Internet Insanity Index." The compilation
consists of 66 leading Internet stocks, from America Online to Xoom.com.
Even after a bummer of a month in May, the group is up something like 75%
for the year. From the low in October through the end of last month, the index
appreciated a mere 453%, and since the start of 1997, it has risen a neat
1,000%!
All told, the current market value of the 66 companies in the index totals a hefty
$430 billion. The vast majority of the stocks have a negative P/E, since, as is no
secret, there ain't no E there.
But each of the 66 online companies has at least a smidgen of sales, so it's
possible to use another common valuation yardstick: price times sales. Median
price-to-sales ratio: 30. Average price-to-sales ratio: nearly 60.
And while the Internet stocks aren't the whole market, which last time someone
bothered to count was worth $11 trillion, in most sessions these past two years,
they've been a pretty fair proxy.
Of course, Mr. Greenspan is always at pains not to upset the stock market.
For one thing, he's the stock market's best friend, and he still remembers with
considerable angst what happened the last time he thoughtlessly visited grief on
the market, back in '87. More importantly, though, he's quite conscious of how
critical the great bull market has been to this most amenable of economic
expansions and, by extension, how critical it has been for his resplendent
reputation.
The chairman's conundrum is however much he feigns not to see it, in his heart
he knows he's living with an asset bubble. And just not any asset bubble, but
one of the grandest in the history of speculative man. He's also aware that
there's no way to gently deflate a bubble, certainly not one that is so
encompassing and large as this one.
His deepest desire, no doubt, is that he'll wake one morning and the cursed thing
will have quietly faded from view. And he often acts as if he carefully tiptoes
around it, professing, as he did last week, not to recognize its existence, maybe
it'll behave itself, grow no bigger and refrain from abruptly bursting.
Obviously, though, there are times when he feels compelled to take action, and
last Thursday he indicated this is one of those times. The way to confound and
propitiate Wall Street, while simultaneously letting a bit of the air out of the
bubble, he evidently believes, is to make clear an intention to raise rates, but
obscuring the true reason for doing so.
Thus, a week from Tuesday when interest rates are lifted a quarter of a
percentage point, the official explanation will be that the hike is being prompted
by "imbalances" that could induce inflation in the economy. The real explanation
is deep concern that, unless deterred, the mania gripping the stock market will
end in tears, and so, in that case, will the expansion.
Wall Street breathed a sigh of relief after the chairman's testimony, persuading
itself that this will be a one-shot increase. Even bond traders sighed with relief,
hopeful that, in terms of Fed action, the worst is over. We sympathize with the
sentiment and think it's dead wrong.
And we think so on several counts. The first is no way a bubble so enormous
and so long in the making can be contained by one tiny boost in interest rates.
As Bob Farrell points out in his current "Theme and Profile Investing," our stock
market now accounts for 53% of the total value of all global markets, up from
28% a decade ago. It has returned 24% a year for the four years through '98,
the highest return for any four-year stretch on record. It has attracted a record
flow of investment from abroad, and individuals not only own more stock than
ever before, but they're stepping up their buying.
Trying to stop this kind of investment momentum with a 25-basis-point increase
in the cost of credit is the monetary equivalent of trying to stop a tank with a
peashooter.
And since Mr. Greenspan's attempt to pre-empt dismay among investors with
soft words and the promise of only modest action seems likely to encourage a
fresh burst of speculative activity, the first rate hike will be followed by another.
Nor will that be the final one. For if the Fed pursues a policy of damage control,
it'll have to do so in what's left of this year. Next year, in case you've forgotten,
is an election year, and we don't reckon the governors will have the stomach or
spine to play tough guy.
Besides conviction that the Fed's their friend, investor appetites will be whetted
in the weeks and months ahead by a rush of favorable corporate reports, as
expanding margins and mounting sales lend a brighter-than-anticipated glow to
many a bottom line.
A pal of ours, with a panoramic perspective on the planet's markets (and who
trades them all), expresses similar views. He compares the Fed's action with
central bank intervention in the foreign-exchange markets, where the first move
is never the last.
He, too, scoffs at the notion that one small boost in rates will do the trick. More
likely, he contends, things will unfold much as they did in Britain three years
ago, when the Bank of England, in order to quell a flare-up in inflation, had to
take rates from 5.5% up to 7.5%. Or, possibly, we're where Japan was in
mid-July of 1989, when Tokyo began to get real about its bubble and lifted rates
in what proved to be the first of many increases.
Our friend is also quite disdainful of Mr. Greenspan's confidence, articulated to
his slack-jawed congressional audience, that even if we have a bubble and the
bubble bursts, the Fed can come swiftly to the rescue and limit collateral
damage to the innocent economy. In support of this cheering optimism (only the
chronically dyspeptic would call it hubris), the chairman suggested that had the
Japanese acted with proper dispatch, they could have saved their economy a
heap of woe.
As our man says, even Mr. G would agree that by May of '96, the Japanese, as
he puts it, "had gotten it" and moved aggressively. "They doubled their budget
deficit and took rates to zero," he snorts, "and three years later, I don't see any
phenomenal recovery."
Our friend is a raging bear on bonds, corporates especially. Besides the hostile
interest rate environment he envisages, he cites the flood of bonds coursing
down the pike. "This will be the largest year of debt issuance," he marvels, "in
the history of mankind. The global corporates are just swamping the world in
debt issuance. They're continuing to sell debt and buy in equity," which could
add fuel to the flaming stock market but stacks up as death for bonds.
"Corporate paper," he exclaims, "will just get absolutely tattooed. It's a
no-brainer. Just close your eyes and sell every bit of corporate paper you can." |
