Nick Godt

Return to Article

Greenspan Warns, Stocks Rally

Nick Godt

While Federal Reserve Chairman Alan Greenspan said that Isaac Newton's basic law of physics also applies to asset prices, the stock market chose to defy gravity in the last hour of trading Tuesday.

"History cautions that extended periods of low concern about credit risk have invariably been followed by reversal, with an attendant fall in the prices of risky assets," Greenspan said; his comments seemed to spur a 45-point jump in the Dow Jones Industrial Average.

It wasn't so much what the Fed chairman said as what he didn't say, which was anything new, that proved a relief for the market.

"There was nothing surprising in the speech," says Owen Fitzpatrick, head of U.S. equities at Deutsche Bank. "That opened the door for a late buying opportunity."

But the afternoon bounce proved short-lived, appropriate for a session in which major averages struggled to find direction. The Dow closed up 0.12% to 10,456.21 after trading as low as 10,416.62 and as high as 10,496.25 intraday. The S&P 500 rose a fraction to 1215.66 while the Nasdaq Composite dipped 0.24% to 2116.42. The benchmark 10-year Treasury rose 1/32 to yield 4.29%.

Despite the Dow's and S&P's gains, declining stocks led advancers 19 to 14 in Big Board trading, where 1.9 billion shares changed hands. Losers led 16 to 13 in over-the-counter trading, where 1.65 billion shares traded.

While steering clear of any direct comments on the impact of Hurricane Katrina, Greenspan reiterated the Fed's faith in the ability of the economy to weather shocks -- such as the bursting of the tech bubble or the more recent surge in energy prices -- "reasonably well."

A slew of Fed officials -- it was San Francisco Fed President Janet Yellen's turn Tuesday -- have already hammered away that they expect Katrina's impact on the economy to be temporary, and that the central bank's main priority remains fighting inflation.

Greenspan, however, spent a large part of his speech justifying why the Fed had not burst the tech bubble in the 1990s, emphasizing that it was not the role of monetary policy to control asset prices:

"By the late 1990s, it appeared to us that very aggressive action would have been required to counteract the euphoria that developed in the wake of extraordinary gains in productivity growth spawned by technological change. In short, we would have needed to risk precipitating a significant recession, with unknown consequences. The alternative was to wait for the eventual exhaustion of the forces of boom. We concluded that the latter course was by far the safer. Whether that judgment continues to hold up through time has yet to be determined."

Noteworthy on its face, those comments about the tech bubble take on heightened significance given that Greenspan has intensified warnings about asset prices recently, most notably housing. Greenspan's comments came after the Census Bureau reported that sales of new homes fell 9.9% in August from 1.373 million in July. Economists expected a rate of 1.350 million new homes to be sold.

Major homebuilders fell in reaction, with Toll Brothers (TOL Quote) losing 1.6% and KB Home (KBH Quote) shedding 1.9%. Lennar (LEN Quote) was relatively strong after reporting better-than-expected earnings and strong guidance late Monday but still slid 0.1%.

Psychology vs. Sentiment

Signs of cooling in the housing market have multiplied over the past month and a half. Even as sales of existing homes roared past expectations in August (as reported Monday ) the data showed an increasing buildup in inventories, which could put further downward pressure on home prices going forward.

In a previous speech Monday, Greenspan said that even if a downward trend in home prices were to continue, most homeowners would be cushioned by the equitiy in their homes.

If that's true, that would be reassuring for the outlook of consumption, especially after Tuesday's news of a post-Katrina plunge in consumer confidence in September. The Conference Board's consumer confidence index fell to 86.6 in September from 105.5 in August, reaching a two-year low. This is also the third largest one-month drop in the index's history, which began in 1985.

According to Charlie Kenny, president of consumer psychology consulting firm Right Brain People, the emotional comfort associated with the values of homes is a far better indicator of consumption patterns than sentiment surveys.

Consumer confidence surveys, as the Conference Board's, only assess superficial attitudes, Kenny says. "They tap into the rational, or left brain, side of the consumer. They do not access the emotional side of the consumer, the right brain, where motivation is located."

As these attitudes can change from one hour to the next hour, "they are not stable, not reliable."

The booming housing market however "is a reflection of a much deeper sense of security and the quest for emotional security that will never be measured by telephone surveys," he continued.

The Fed is also concerned that soaring energy costs eventually will seep into core prices and that government spending for post-Katrina reconstruction will boost inflation next year. And if home equity will help consumers weather soaring energy costs, short-term rates may have to go much higher still.

To view Gregg Greenberg's video take on today's market, click here.