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Ten years after then-Federal Reserve chairman Alan Greenspan questioned whether the United States sharemarket suffered from "irrational exuberance", share prices are rising again - but the rally may be more rational this time.
"I don't see the imbalances today that started to appear in the late 1990s," said David Joy, of RiverSource Investments in Minneapolis. "Certainly we forget the lessons we learn over time but it still seems to me that investors now are mindful of valuations."
The Standard & Poor's 500 index has climbed 91 per cent during the past decade, a period that included the worst US bear market since the 1970s. Even with the advance, the S&P 500 is valued at 17.8 times earnings, down from 20.7 when Greenspan spoke and an average of 21.9 in the past four years.
Commodities and real estate started surging in 2001 as stocks retreated and emerging-market stocks led a worldwide rally during the past three years. All three have stumbled this year, although the Morgan Stanley Capital international emerging markets index set a record this week. Greenspan used the "irrational exuberance" phrase in a December 1996 speech.
The talk included this question: "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?"
Japanese stocks were about 50 per cent below their peaks, reached at the end of 1989, when he spoke. Share prices did not hit bottom until April 2003, when the Nikkei 225 stock average showed an 80 per cent loss.
The question sent stocks tumbling worldwide. The Nikkei 225 dropped 3.2 per cent. Europe's Dow Jones Stoxx 600 index declined 2.2 per cent while the S&P 500 slipped as much as 2.4 per cent before recovering to close with a 0.6 per cent loss.
US Treasuries and the greenback fell in overseas trading on his comments. They rebounded in the US after a report showing lower-than-forecast job growth eased concern that the Fed would raise interest rates.
"That was my first Fed memory," said Drew Matus, of Lehman Brothers in New York, who was working on the central bank's markets desk in 1996. "We knew what was going on in the equity market but, to hear Greenspan argue that people were being a little aggressive, it stands out as one of the days at the Fed that I'll remember."
Greenspan's comments stemmed from a lunch meeting two days earlier with Yale University Professor Robert Shiller and his research collaborator, John Campbell. They presented data showing the higher share prices are relative to earnings, the lower returns may be in the next 10 years.
The impact on US stocks, then in the middle of the so-called internet bubble, was shortlived. The S&P 500 retreated 2.2 per cent in December 1996 and then rebounded 6.1 per cent the next month.
Share prices rallied through March 2000, when the S&P 500 peaked at an all-time high of 1527.46. In that same month, Shiller's studies were published in the book, Irrational Exuberance, arguing that anyone who wanted to invest in stocks at the time was irrational.
The S&P 500 slumped 49 per cent by October 9, 2002, as the internet bubble burst, the US economy fell into recession and the September 11 attacks also battered financial markets. Technology companies led the retreat.
"I don't think it was the 'irrational' statement at all that caused people to be more realistic," said Jim Russell of Fifth Third Asset Management in Cincinnati.
"It took the bear market and the experience of the dotcom bubble."
"Today there isn't that optimism that would be reflected in the words irrational exuberance," said Ken Fisher, of Fisher Investments in California.
"We got very high in the late '90s and people still suffer from the emotional overhang of the bear market."
- BLOOMBERG
