Former Fed Chief Greenspan Sees No Bubble in Dow 16,000
Comment of the Day

November 28 2013

Commentary by David Fuller

Former Fed Chief Greenspan Sees No Bubble in Dow 16,000

Here is the opening of this report from Bloomberg:

Former Federal Reserve Chairman Alan Greenspan said the U.S. economy probably will grow more slowly next year than some forecasters predict and indicated that a record U.S. stock market isn't in a bubble.

"This does not have the characteristics, as far as I'm concerned, of a stock market bubble," Greenspan said in an interview on Bloomberg Television's "Political Capital with Al Hunt," airing this weekend. "It could come out that way but I don't see it at this stage."

Greenspan said that even with the rise in equities, the U.S. economy is restrained by a "degree of uncertainty" that is reducing investment. Economists who forecast 2.5 percent to 3 percent growth next year may be too optimistic, he said.

"It's a little on the upside, frankly," Greenspan said. "There's no doubt that there's been some acceleration going on, but there's an overall suppression that is going on in the economy" largely because of lingering uncertainty, he said.

Greenspan said his 2014 growth forecast is "closer to 2 percent." That's below the median estimate for a 2.6 percent expansion next year after a 1.7 percent growth this year, according to a Nov. 8-13 Bloomberg survey of 73 economists.

Greenspan said the economy is being held back in part by the banking system, as some of the largest banks are not operating efficiently.

"We're supporting banking institutions who are not only very large, but not very efficient and they are using the scarce savings of the society, which is critical for economic growth," he said. He declined to identify which banks had become inefficient.

David Fuller's view

Alan Greenspan is being diplomatic and he does not wish to put any additional pressure on Janet Yellen who is taking over leadership of the US Federal Reserve at a challenging time in terms of the Central Bank's policy of quantitative easing (QE).

Mr Greenspan does not see a bubble in the DJIA and he is right, but this average of 30 mature companies, although not cheap at a P/E of 15.57, according to Bloomberg, is the last place one would expect to find evidence of a developing bubble in the US stock market. However, might we be seeing some 'irrational exuberance' in some fashionable tech stocks which have little or no earnings? Also, consider also high flying US retailers, some of which are trading at P/Es in the mid-20s. How about tech retailer Amazon which has recently accelerated higher? It has an historic P/E of 1381 and an estimated P/E of 387. Meanwhile, the broad-based NASDAQ Composite Index, where I would look for evidence of a bubble, is trading at a P/E of 24.75 and D/Y of only 1.4%.

As Chairman of the Fed, Greenspan made his irrational exuberance comment on December 5th, 1966 in the latter portion of his speech: The Challenge of Central Banking in a Democratic Society:

"Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. 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?"

Needless to say, he was castigated for the 'irrational exuberance' remark by Wall Street and some CEOs high on stock options, as veteran subscribers may recall. Consequently, an irrationally chastened Greenspan said little about the damaging bubble which continued to inflate before bursting a little over three years later.

Surely the art of central banking should include the ability to identify a potential bubble in its early developing stages, and gradually withdraw liquidity before it becomes an obvious bubble. These usually burst with damaging economic consequences, although 1987 was an exception as Greenspan also mentions in the above speech.

Janet Yellen knows all this, not least because it was Ben Bernanke's initial intention to fuel a stock market recovery in the hope that it would be perceived as a lead indicator and in rewarding investors, would increase confidence in the economy. However, she may feel that a potential stock market bubble is less of a risk than a US economy which has underperformed the Fed's expectations to date.

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