Fed chief Janet Yellen just had her “irrational exuberance” moment yesterday. And that’s important for your investments.
Much-maligned (and deservedly so) former Fed chief Alan Greenspan invented the term “irrational exuberance” on December 5, 1996. It came during his speech to the American Enterprise Institute:
“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? And how do we factor that assessment into monetary policy?”
Yeah, Greenspan’s market timing was pretty bad. But still, he asked a couple of relevant questions: How do we know when stocks are in a bubble? And does the Fed have a responsibility to act when bubbles appear to be growing?
It’s more than a little ironic when the Fed asks about bubbles, since bubbles are usually the Fed’s fault. After all, the Fed makes money cheap via low interest rates to get more money invested.
Of course, some of that cheap money will get invested poorly and create imbalances in the economy that ultimately get exposed when asset values fall.
It’s even more ironic that Greenspan deliberately went after the Internet bubble with a .50 bps rate hike in March of 2000 but then inflated the housing bubble with his tolerance for low rates and support for credit swaps and other derivatives that supposedly spread risk around the globe.
Oh, those derivatives spread risk all right — to the point that the entire global banking system nearly crashed.
At the time Greenspan uttered the phrase “irrational exuberance,” the S&P 500 had nearly doubled in two years, running from 450 to 750. The P/E ratio for that index was around 18 at the time, about where it is now.
The S&P 500 would double again — to 1,498 — by the time Greenspan acted and the bubble popped. The P/E for the index was above 30 for over a year. Earnings for S&P 500 companies peaked at $56.13 a share in 2000.
Some people still like to say that Greenspan was right about irrational exuberance — he was just three years early. To me, if you miss a forecast by three years, you’re not early; you’re just wrong.
So what does it mean that Janet Yellen just had her “irrational exuberance” moment before Congress yesterday? Glad you asked…
Dammit, Janet
In case you missed it — and I sincerely hope you did and aren’t a “hang-on-every-word-from-any-market-pundit” nerd like I am — here’s what Yellen said:
“Nevertheless, valuation metrics in some sectors do appear substantially stretched — particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.”
Okay, so like during Greenspan’s time, the P/E ratio for the S&P 500 is around 18. Yellen is clearly early on any bubble call. And for the record, the resemblance between the social media stocks of today and many of the Internet stocks of 1999 is uncanny.
I mean, have you used Twitter? It’s the stupidest, most self-indulgent “media” I’ve ever seen. And calling it “media” is generous. Maybe Twitter will be lucky enough to get bought out soon, because there’s no way that service is worth $22 billion dollars.
Analysts think Twitter will earn $151 million in profit next year. At that rate, it would take 153 years to pay off that $22 billion market cap. What a great deal!
Anyway, let me get back to the point, which is that Janet Yellen is noticing some stocks are starting to look a little bubblicious. The question we have to ask is this: Does Janet have the stones to raise interest rates before the S&P 500 trades at a P/E of 30 for over a year?
Okay, maybe that wasn’t the best way to phrase it. But will she have the guts to act?
Frankly, I have to go with yes. I think Janet will hike rates before the S&P 500 trades at a P/E of 30 for a year. (With any luck, I’ve set those parameters wide enough that I can’t be wrong…)
Now, let me just add something in Greenspan’s defense. And I’ll tell you straight out that I haven’t ever defended the man. But he did preside over the birth of the Internet.
It was an absolutely revolutionary time. Productivity numbers were off the charts as corporations went online. I can understand that you don’t want to be the one to choke the Golden Goose before it lays the golden egg.
Today, probably 30% of Internet bandwidth is consumed by videos of baby goats jumping on one another. Sure, it’s cute. But there ain’t no Golden Goose.
I’d jump at the chance to choke Twitter off with an interest rates hike.
Get Ready for the Blow-Off
Right now, the U.S. economy simply doesn’t have “it’s different this time” potential.
There are no revolutionary innovations changing the economy (though there is some pretty cool technology with robots and 3D printing, and one of those biotechs Yellen panned may well have a cure for cancer).
We’re just trying to get some debts paid off, increase jobs, and fuel some consumer demand.
And Yellen isn’t going to mess with that — at least, not while there’s a chance low rates are helping. So she’s resorting to the age-old Fed tactic of jawboning.
Jawboning is just talk. Yellen would like to talk down some overvalued assets. But it won’t work because investors know well that she is talking instead of acting. So we can look forward to higher prices for stocks.
We have entered the exuberance phase of the bull market. It could last a year or more. If you haven’t made enough money in stocks over the last few years, get ready.
Stocks are going higher.
Until next time,
Until next time,
Briton Ryle
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
