Markets have been on an extraordinary and remarkable ride over the last 10 years. Actually, for stocks it’s been a wild 25-year ride while bond yields and interest rates have generally trended lower for the past 35 years.
On Dec. 5, 1996, Alan Greenspan used the words “irrational exuberance” to describe the stock market. I had leveraged positions in stocks at the time; I was irritated that the Chairman of the Federal Reserve would inject his views into markets as his comments caused the S&P 500 to fall. However, that drop was just a blip. At the time the S&P 500 was trading at 590. By the year 2000, the S&P 500 hit a high of just over 1500. Everybody I knew thought that they were a day trading whiz.
Then came the bursting of the dotcom and technology bubble. Over the next two years the S&P 500 lost nearly half of its value. And we all went back to our day jobs. In the end, Alan Greenspan was correct.
Then came another bubble, this time in housing. Before the bursting of the housing bubble stocks had recovered all or their losses of the dotcom era. Ironically, much of the blame for the housing bubble has been placed on Alan Greenspan for not raising short-term interest rates in order to slow home prices and the appeal of “exotic” mortgage products. The truth is there is plenty of blame to go around, including overleveraged homeowners.
From its high in 2000, the S&P 500 didn’t trade again to that level until 2007, just before everything fell apart in 2008. In October of 2007, the S&P 500 was just over 1500, in March of 2009, it hit a low of about 675, not much higher than where Alan Greenspan had made his “irrational exuberance” comments more than 10 years earlier.
With the bursting of the housing bubble and the onset of the “Great Recession,” the Federal Reserve stepped into markets full-force under the leadership of Ben Bernanke. Short-term interest rates were dropped to zero, and the Federal Reserve took additional the “extraordinary measures” of buying over $4.5 trillion in bonds over the next 5 years.
They called their strategy the “portfolio balance channel” or “quantitative easing.” Their objective was to push the yields on safe-haven assets such as US Treasury bonds so low that investors would be forced to take risks, including investing more heavily in stocks, in order to jump-start a lifeless economy.
Moving forward to today, the Federal Reserve has just recently begun to wind-down their $4.5 trillion bond portfolio acquired through quantitative easing. At the same time, the Federal Reserve has begun to raise short-term interest rates on a regular basis and projects several additional increases.
Stocks have been on a remarkable run since hitting the lows in 2009. I readily admit that I have never been a believer in the long-term endurance of the continuing rally, rather attributing the rally to the Federal Reserve’s and other global central banks’ “extraordinary measures” rather than a significant improvement in the economic outlook.
However, most recently there are signs of an increase in the rate of economic growth, but stock prices as measured by price-to-earnings ratios and other fundamental measures of value remain well ahead of that actual economic growth.
In conclusion, I thought that Alan Greenspan was out of bounds in 1995 when he made his “irrational exuberance” statement which caused a short-term drop in stocks. For the last several years I have been confounded by what has become to be known as the Greenspan, Bernanke, and Yellen “put,” A reference to the fact that every time markets falter the Federal Reserve steps in with monetary support. The Fed is currently rolling back their market support as the economic outlook improves. Will we return to a healthy economic environment before the next big shock? That is a question that could be answered in 2018.