Irrational Exuberance, One Year Later

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What were you doing 1600 points ago?

For

Federal Reserve Chairman Alan Greenspan

, the answer to that question should come easily. He was the keynote speaker at the annual dinner and

Francis Boyer Lecture

of the

American Enterprise Institute for Public Policy Research

in Washington.

Friday marks the one-year anniversary of the near-legendary "irrational exuberance" speech by Greenspan.

"But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?" asked the chairman on Dec. 5 last year, and, for a moment, stocks shuddered. Many on Wall Street had already been leery of high price-to-earnings ratios. That Greenspan as well was apparently worried about valuation sparked fears that if Wall Street did not heed his warning, he would knock down stocks with the only real tool he had on hand: an interest-rate hike. On Dec. 6, the

Dow

fell as much as 162.86 points intraday (a fairly big loss back in those days) before recovering to close down 55.16 at 6381.94.

But despite all the hoo-hah about irrational exuberance, stocks got right back on their feet. Indeed, they dutifully climbed to new highs before the year was up and kept climbing. Even when Greenspan reiterated the "irrational exuberance" warning at his

Humphrey-Hawkins

testimony in February, stocks took little more than passing notice. A drop to 6391 in April (on rate-hike fears), and they were on their way to 8000. So much for investing with the chairman.

"God, he was right about the stock market, wasn't he?" quips

Nikko Securities

chief economist Bob Brusca.

Just about everyday some reporter, somewhere, hits the "irrational exuberance" macro on his keyboard. A

Dow Jones News/Retrieval

search for the last year yields 4,240 articles -- along with 117 stories talking about "rational exuberance" and 15 with "irrational exuberence."

But besides that, what kind of legacy do we have of Greenspan's speech on the first anniversary?

"I don't think anyone could care less" about the anniversary of the speech, said one trader in the midst of Thursday's action. Indeed, the Fed chair doesn't spend much time worrying about the stock market anymore, or if he does, he does it in private. One year after his speech, and maybe that's the point: He doesn't really talk about stocks anymore.

True, asset inflation is, and should be, a concern of any central banker -- the frothy prices of assets across the board in Japan and, more recently, Southeast Asia, presaged problems for those economies for some time to come. But the situation in the U.S. is a far cry from Japan's bubble economy, where, besides high stock prices, real estate was going through the roof and last year's VCR model was set out on the curb with the rest of the garbage.

But if only one asset is overvalued, that's not really a threat. It's like saying that a jump in pepper prices constitutes inflation. Maybe the Fed should watch those pepper prices, but it's not a reason to hike. Same goes for stocks, according to James Griffin, international economist and strategist at

Aeltus Investment Management

.

"If we all decide that we never want to buy another car but bid up

Merck

, what's the Fed supposed to do?" he asks. And whether, even in that preposterous case, stocks are fairly valued -- well, you can argue about that till the cows come home.

And one year later, we also have a different idea of what kind of risks Greenspan saw. Or sees now.

"He may have overstepped a bit, but he has since clarified his comments in a very constructive way," says

Merrill Lynch

senior financial strategist David Horner. Where a year ago the read on Greenspan's comments was that he was worried about the price of stocks, today people believe that he what he was really worried about was the pace of their advance, according to Horner. This may be the case, or it may be that as Greenspan's own thinking has evolved, he has been able to cast his comments in a different light. A subject for cocktail conversation, and little else. Either way, the Federal Reserve chairman and the stock market have buried the hatchet.

"I think he's learned his lesson," says Nikko's Brusca. "He's made his peace with the world, and let the stock market do what it will."