In late August 1999, on the precipice of one of the great ill-advised buying binges in the history of market capitalism, Alan Greenspan noted publicly that the world isn't always a rational place.
"Enough investors usually adopt strategies that take account of longer-run tendencies to foster the propensity for convergence toward equilibrium," the
chairman said, inimitably. "But from time to time, this process has broken down as investors suffer an abrupt collapse of comprehension of, and confidence in, future economic events."
Greenspan was referring in part to the collapse of Long Term Capital Management, which was still fresh. But his warning was also intended as a message to markets that were starting to run ahead of fundamentals. The warning was received too late, and despite a year-long campaign of tightening, existing liquidity was enough to spur a speculative frenzy in 1999 and 2000.
Could we be making the same mistake again?
Greenspan probably doesn't think so, economists said. Though the current eight-week bull run has hallmarks of a stock bubble, most economists say the Fed chairman and his team are unlikely to put away their rate shears now. A weak economy remains the primary concern.
The conventional definition of a bull market is a 20% rise, and since April 21 the
Dow Jones Industrial Average has shot up 19.8%, the
S&P 500 has gained 17.9%, and the
Nasdaq Composite Index has popped 33%. While it's debatable how much of the surge is Fed-related, the central bank's easy-money policy is generally given some of the credit (or blame). Greenspan has chopped interest rates 10 times since the beginning of the year, aggressively lowering the fed funds target to 2% from 6%.
"Another bubble in the stock market due to more easing is a more distant worry at this point," says Josh Feinman, chief economist at Deutsche Asset Management Americas. "It's outweighed by concern over the near-term fragility of the economy. Once we're sure the economy is strong, we'll start tapping on the brakes and worrying about overstoking things," he said.
The risks of a deep global recession include an potential undermining of public support for globalization, deregulation of industry and economic reform, "all things that Greenspan and many others think have contributed to the U.S. performance," said Jim Glassman, senior U.S. economist at J.P. Morgan Chase.
In the meantime, the Fed probably would like to see more of the current performance from the stock market. Equity investments now account for 30.3% of household wealth in 2000 compared with 13% in 1990, and consumer confidence often closely mirrors the stock market. "They're not going to pull back just because the market's starting to get happy. The Fed would like consumers and businesses to spend," says Glassman. "He wants to make sure people aren't irrationally pessimistic."
The current run-up doesn't hold a candle to the sprint in equities in 1999 and 2000. While valuations on many stocks are high, equities are still down sharply this year. The Dow is off 8.5% this year, the S&P 500 has lost 14%, and the Nasdaq is 23% below where it began the year. "You don't have the same kind of speculative fever," says Paul Kasriel, chief U.S. economist at Northern Trust of Chicago. "You don't have the same kind of hype in terms of projections of corporate profits. You don't have people chasing dot-coms."
Indeed, the major indices are basically just above where they were before Sept. 11. "The market is just back to Labor Day levels. There's no reason the
Fed wants to pump up
the stock market. But there's no reason they want it to be down as much as it was after Sept. 11 either," Glassman said.
Pushing Out Pain
Still, the danger remains. If another bubble does form, it will just delay the economy's pain, says Paul Kasriel, chief U.S. economist at Northern Trust of Chicago. "The cure for those booms and bubbles is not more monetary stimulus but rather a readjustment in the economy," says Kasriel. Rather than give businesses interest rate handouts, we need to let more of them fail so that resources move into more productive areas of the economy, he says.
Especially in its current state, the economy wouldn't be able to stomach a sharp reversal in interest rates if the stock market gets out of hand, he said. If the Fed were forced to deflate another bubble quickly by raising interest rates, "that might be a shock to the economy that would just be unbearable, given the state of household and corporate balance sheets right now," Kasriel said.