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Non-Tech : Tulipomania Blowoff Contest: Why and When will it end? -- Ignore unavailable to you. Want to Upgrade?

To: Sir Auric Goldfinger who wrote (807)	1/22/1999 8:06:00 AM
From: Hiram Walker	Respond to of 3543

Auric, a good article about Greenspan from Stephen Roach(what a good economist). US: Bubble Rubble? Stephen Roach (New York) Alan Greenspan has finally 'fessed up. More than two years after he first warned of "irrational exuberance" in the stock market, he has changed his thinking on the perils of America's asset bubble. In his latest words, "...a flattening of stock prices would likely slow the growth of (consumer) spending, and a decline in equity values, especially a severe one, could lead to a considerable weakening of consumer demand." Greenspan has fought this one from the get-go. After taking a lot of flack for his initial remarks of December 1996, he quickly retreated into the fuzzy logic of the standard Wall Street valuation call. His conclusions are hardly surprising. In an era that he perceives to be characterized by enhanced productivity growth and concomitant upside surprises to earnings, a low interest rate backdrop makes for a compelling valuation case for stocks. Even so, Byron Wien's dividend discount model -- which takes many of these same considerations into account -- suggests that the S&P 500 is now about 13% over-valued, on the basis of current bond yields (5.17%) and a $50 estimate of 1999 earnings per share. If , by some outside chance, earnings dip by 2.5% rather than increase by 8% as Byron reckons, then this same model would find stocks about 25% over-valued. And this says nothing about the Internet bubble. In large part, this piece of the argument covers familiar ground that the Fed Chairman has explored off and on over the past two years. Greenspan is basically making the point that central bankers need not worry about the asset bubble for as long as it doesn't pop. Good luck. What was new about Greenspan's 20 January congressional testimony, however, was his attempt to analyze the linkage between wealth creation and the pace of the real economy. Like many, he threw cold water on the worrisome signal now being flashed by a "zero" reading on the personal saving rate; not surprisingly, he underscored the widely known distortions arising from the exclusion of capital gains but the inclusion of capital gains tax liabilities in the income side of the saving equation. But he conceded that this statistical distortion does not reconcile the recent burst of consumption growth with conventional measures of personal income. This is entirely consistent with my own thinking, which stresses that the bulk of the consumption overshoot of the past three years has been caused by a rare late-cycle burst of wealth-sensitive spending on durable goods (see "Bubble Trouble", December 2, 1998). In other words, the consumption boom, which lies at the heart of the recent vigor of the US economy, has all the symptoms of being driven by a powerful wealth effect. A sharp and sustained stock market correction, in this context, would undoubtedly deal a lethal blow to the US economy. So what can the Fed do? Not much, according to Greenspan's latest utterances. In his words, while asset values "...must be carefully monitored, ...they are not themselves a target of monetary policy." Yet the Fed is very mindful of the devastation that can occur, if and when the bubble bursts. Indeed, in his brief "irrational exuberance" period -- set against the backdrop of Dow 6437 on December 5, 1996 -- Greenspan painted a grim picture of a post-bubble Japanese economy as a reminder of what could happen in the US. And that was 3000 Dow points ago. Yet the Fed, itself, may be more a part of this problem than Greenspan is willing to concede. By taking the view that inflation is dormant and/or the proverbial slowdown is always around the corner -- a conclusion Greenspan just underscored yet again in the aftermath of the Brazilian crisis -- the central bank has essentially taken interest rate risk out of the equity valuation equation. The result has been an extraordinary green light for equity investors for nearly two years. Unlike Greenspan, who judges stock prices largely on the basis of a future earnings stream, the MSDW dividend discount model has long been more sensitive to interest rates than earnings. In our view, an accommodative Fed and a well-behaved bond market are all that the stock market really needs. And that's exactly what has transpired in recent years. Of course, the day will eventually come when this will all change, and the Fed will embark on a classic late-cycle monetary tightening. If the stock market hasn't already corrected by then, the asset bubble and the real economy could be in for real trouble. If the Fed shies away from such a policy shift, then asset price inflation will undoubtedly spill over into the prices of goods and services in the real economy. That's when the rout will be on in the bond market. And then Greenspan will have to come face to face with what could be the rubble of a post-bubble US economy. I still say Europe has to fall first,look for Turkey or Greece,or maybe Luxemborg first. Luxemborg could go bankrupt and I think they would have to equivalent effect of a McDonald's closing in Russia. Hiram