The Fed Chairman Takes a Bullish Stand
Don't be fooled by his famous ambiguity. Greenspan is making a strong case for buying growth stocks now.
(MONEY Magazine) – Being an oracle is a tough job, especially if you want to retain your credibility over an entire career. You have to be smart and provocative yet leave a little wiggle room. No one today understands this art of oracular discourse better than Federal Reserve chairman Alan Greenspan, who reportedly once told Congress, "If I seem unduly clear to you, you must have misunderstood what I said."
Nonetheless, Greenspan has been remarkably outspoken over the past few months. His syntax may still be convoluted, but the Fed chairman is clear about how he sizes up today's economy: He believes it still has room to run. And if you follow his analysis to its logical conclusion, you wind up with a strong economic case for investing now in the shares of large growth companies.
Today's Biggest Puzzle
What makes Greenspan's optimism particularly noteworthy for investors is its contrarianism. A majority of money managers polled in a recent Merrill Lynch survey, for example, say that the current global economic expansion is nearly over. But Greenspan says conventional thinkers are misreading the facts, and his opinion deserves attention--after all, unlike other economists, he gets to set the level of short-term interest rates.
It's the market, however, that sets long-term rates, and their puzzling decline this year has been the most persuasive argument for economic pessimism. Even as Greenspan and the Fed raised short-term rates by two percentage points over the past 12 months, yields on 10-year Treasuries dropped three-quarters of a point. "This is clearly without recent precedent," he told Congress in June.
The shrinking gap between short-and long-term interest rates creates a pattern known as a flattening yield curve. Normally, this is a sign that inflation pressures are abating and that the demand for money is weakening. In theory, both could signal the onset of a slump, and indeed, that's how most economists are interpreting things.
But Greenspan and other contrarians don't buy it. Instead, they believe that interest rates are being held down in part because of some unusual but not necessarily worrisome forces. The most important of these is globalization, as Greenspan explained in June when he addressed the International Monetary Conference in Beijing by satellite. "The breakup of the Soviet Union and the integration of China and India into the global trading market...have permitted more of the world's lower-cost productive capacity to be tapped to satisfy global demands for goods and services." In short, cheap imports, not a weakening economy, are keeping U.S. inflation low.
In addition, the U.S. dollar remains the currency of choice for the world's excess savings. Countries selling us imports are therefore investing much of their profit in Treasury bonds. That too has helped push down long-term yields.
Even these two factors don't fully explain the recent behavior of long-term rates, which Greenspan has called a "conundrum" (thereby making the "c" word the hottest new coinage in the economic lexicon). But he doesn't think that the explanation is an approaching slump. Over the past year, as Greenspan pointed out to Congress, real gross domestic product grew by 3.7%, unemployment dropped to 5.1% and inflation hit just 2.8%. Not so long ago, that would have been considered a near-perfect economy.
Refuting the Pessimists
Even if interest rates weren't a conundrum, economic worriers would have plenty else to keep them occupied. There's the high cost of oil, which has been a serious drag on growth. Since the end of 2003, the rise in the value of imported oil--essentially a tax on U.S. residents--has cut about three-quarters of a percentage point from the economy's growth rate, Greenspan told the Economic Club of New York in late May. But energy costs aren't likely to sink the recovery unless they keep moving higher. After all, GDP has been able to grow steadily despite the energy spike, and that resilience is a sign of strength. Moreover, most economists, Greenspan concluded, think the price is likely to ease over time.
The pessimists also fear that a collapse in home prices could tip the economy into recession, just as the tech-stock crash did in 2000. Greenspan's answer: "A 'bubble' in home prices for the nation as a whole does not appear likely...speculation in homes is largely local." While he acknowledges that some home buyers are borrowing more than they can afford, he adds that for most current homeowners, a moderate drop in prices would have little effect on monthly spending. "Although we cannot rule out home-price declines," Greenspan told Congress, "these declines...would not have substantial macroeconomic implications." In other words: Bubble, schmubble.
Adjusting Your Portfolio
How do you translate Greenspan's contrarian outlook into an investment strategy? Buy companies that stand to prosper if the economic expansion keeps going--that is, growth stocks. Because the worriers are in the majority, conservative choices--such as utilities and consumer stocks--are expensive compared with their past averages, according to the Leuthold Group, an investment advisory firm. But growth stocks are trading well below historic norms. (See the table.) You don't want to abandon all your conservative holdings, of course, but the time to add growth stocks to your portfolio is when they're cheap. They usually aren't. They are now.
IT'S GROWTH STOCKS' TURN
Pessimism about the current outlook has provided a rare opportunity to pick up undervalued growth stocks. Analysts who share Greenspan's cautiously optimistic view favor blue-chip growth companies like these.
NOTE: As of June 21; P/Es on 2005 results. SOURCE: Thomson/Baseline.