Fedspeak and the 25 Year Anniversary of a Peerless Teachable Moment

Dec 6, 2021 4:58:00 PM / by Jonathan Blau

 

Yesterday, December 5, 2021, marked a significant anniversary in the economic and financial history of the United States, and given the obsession that investors and the financial media have with the recent wordsmithing of our newly reappointed Federal Reserve Chair, Jerome Powell (Vis a vis “transitory” inflation), I couldn’t let it pass without comment.

For it was a quarter century ago, yesterday, on the night of Thursday, December 5, 1996, that the iconic Federal Reserve Chairman Alan Greenspan, speaking at a dinner of the American Enterprise Institute in Washington, gave his instantly legendary “irrational exuberance” speech.

And this is what the oracle said. Or, more accurately, this is what he asked that cost many investors to lose a lot of wealth (not just in the ensuing few years, but for decades – and even generations -- to follow):

“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 do we factor that assessment into monetary policy?”

Mr. Greenspan asked these twin rhetorical questions essentially because he had no conclusive answers. And if he didn’t, odds were that no one else in the world did either. But, coming from him, even in this interrogative form of thinking out loud, it was a financial thunderbolt – a shot heard round the world.

He surely understood that, when he so much as broached the question, he had at least suggested the answer. And that answer was unmistakably: we’re either already there or will be very soon, as this greatest of all bull markets morphs into a mania.

Now let’s take a look at the intervening quarter century, starting with a key data point that may and should inform our lesson.

Fact: The Standard & Poor’s 500 Stock Index had closed that Thursday afternoon, unaware of what was about to come out of Greenspan’s mouth late that evening, at 744.38. And sure enough, just as the oracle had darkly suggested it must – the S & P 500 topped out…three years, three months and 19 days later, on March 24,2000, at 1,527.5. You read that right: the S & P 500 more than doubled (earning about 25% annually) during the 40 months after Greenspan’s dire warning!

I guess I could stop here, invite you to draw the obvious inference and call it a day. The inference is, of course: No one – no central banker, no economist, no market strategist, no hedge fund manager, no TIGER21 (uber-wealthy investment club) member – no one can predict the market, much less tell you where to get out and/or back in. The economy cannot be consistently forecast, nor the market consistently timed. By anyone. More importantly, a successful wealth management outcome not only doesn’t require that, but will almost always be impeded by those who try it.

But, I would be remiss without sharing a few more extremely relevant facts.

  • Coming into this weekend of the 25-year anniversary of the “irrational exuberance” warning, the S & P 500 closed at 4,538.43, up more than 6 times since Greenspan spoke.
  • With dividends reinvested, and any taxes paid from some other source, $1 million in the S & P 500 on 12/4/96 is now worth close to $10 million.
  • The earnings for the S & P 500 in 1996 were $40.63. With less than a month left in 2021, the consensus forecast is around $200, up almost exactly 5 times.
  • The S & P 500’s cash dividend in 1996 was $14.9. Consensus forecast for his year is about $60, up almost exactly four times.
  • The most reliable measure of inflation, the Consumer Price Index, was 158.6 in December, 1996. It will most likely close this year around 280, up a mere 1.8 times.

For clarity, $1 million invested in the S & P 500 in 1996 paid about $20,000 in dividends. If held, that portfolio now pays about $80,000. An investor in a long-term (30-year bond) in 1996 could get about 6.5%, so today that investor is still receiving $65,000 in interest, annually (20% below the income from the current S & P dividends, which are growing like a weed). Moreover, the S & P portfolio would now be worth $6 million, while the bond is still worth $1 million.

What, then, was the single best financial decision one could have made on December 5, 1996 – when the 11 o’clock news breathlessly reported Greenspan’s electrifying remarks? Right: turn off the TV and go to bed!

In closing, just my opinion, but what is the best move you can make today, 25 years on, regardless of the headlines? The same: turn off the TV, log out of your computer. Enjoy the rest of the day. And let the compounding proceed, uninterrupted.

“It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

Mark Twain

Hope everyone continues to be well. Best wishes for a safe and happy Holiday Season!

 

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Jonathan Blau

Written by Jonathan Blau