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Are valuations too high?
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January 8, 1999: 1:53 p.m. ET
Analyst says Fed chief Greenspan is worried about speculative market bubble
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NEW YORK (CNNfn) - The stock market's recent surge has many Wall Street analysts concerned valuations have come too far, too soon.
Some are even comparing the current market scenario to the speculative bubble of the Japanese market in the 1980's.
And while it hardly approaches the 50 or 60 times earnings where Japan's stock market peaked, Aubrey G. Lanston's chief economist David Jones thinks the Dow's recent record may look like a speculative bubble to the most important economist in the land, Fed chief Alan Greenspan.
The following is his "Business Day" interview:
DEBORAH MARCHINI, CNNfn ANCHOR: The stock market's performance, very near record setting right now. Looks like a speculative bubble to you?
DAVID JONES, CHIEF ECONOMIST, AUBREY G. LANSTON: Well, it's more important. Yes it does to me, but the gentleman you mentioned, Alan Greenspan, is the key person here.
I don't think we are going to hear him say a "stock price bubble," but I think he's got a speech scheduled before the House Ways and Means Committee on January 20.
And I am guessing what he's going to say there, in essence, is yes, stock prices are going up faster than earnings prospects. By that definition, in his mind, it is certainly in the range of a bubble.
Now, we have to remember, Deborah, that "irrational exuberance" was mentioned down around 6500 in December 1996 -- 9500, the market shrugged him off.
But the key is, I think he feels there's risk on both sides of the economy. Consumers are tying their spending to rising stock prices. That means too much growth, tight labor market conditions, maybe an inflation risk. By the way, Governor Kelly mentioned that yesterday.
Then, on the down side, once for some reason the bubble breaks, everything turns around and goes down.
So there's a kind of vulnerability to the economy this year, again, in Fed Chairman Greenspan's eyes.
MARCHINI: That stock market's really kind of making it hard for the Fed to do its job, isn't it? I mean, we are seeing stock market money being spent in the real economy to a much greater extent than at least I can remember in 20 years of covering this.
JONES: It's unprecedented, Deborah. And furthermore, I am not trying to say that the stock market doesn't have some good fundamentals.
All that money flowing in, more than 50 percent of the households putting bonus money in the stock market, making long-term commitments to the stock market for retirement. That's power. The power of that liquidity is important and we still have relatively low inflation and relatively low interest rates.
So, you also have that dilemma. So the question is: You're Fed chairman, most powerful guy in the world maybe at this point. You ask yourself, am I smarter than the stock market? Am I smarter than the collective judgment of all those buyers and sellers?
So, you know, he has his problems there, but there is a danger, maybe the biggest danger to the economy this year, both on the upside and the downside.
MARCHINI: Do you think if there is a speculative bubble, it's limited to stock prices?
JONES: Well, good question. No. Look at new home sales. The latest figure was up, I don't know, 7.3 percent, record levels.
People are finally translating… those high stock prices into something that may start to become a real estate price bubble. We had that in the late '80s. Japan had it in a big way in the late '80s.
Japan is still trying to recover from that. It destroys the banking system when you break a bubble that is both stock prices and real estate prices. We are not there yet. That market has remained terribly well balanced, but there is a danger and Greenspan, believe me, is watching that closely as well.
MARCHINI: It's interesting, because I mentioned Japan, you mentioned Japan. We are nowhere near, are we, the level of asset prices and inflated asset values that Japan was near before the government stepped in to pop that bubble?
JONES: Well, no and, Deborah, we have to remember they were greatly over-regulated. They still are too regulated, but there are just so many differences between our capital markets, which have been so efficient, our stock culture where we had good corporate governments and transparent accounting and good reporting and good securities regulation.
We are the class of the world in terms of the efficiency of capital markets and allocating capital to the highest risk-adjusted return areas like technology. Japan didn't have any of that. The banks were just making a lot of speculative bets back then.
So, I wouldn't compare us. And we are not there. In direct answer to your question, we're not at that point. But, you have to say, we have had a stock market that was on the bull a long time. We have to say one that's going up too fast now and the Fed chairman was the guy to follow this.
MARCHINI: I was going to say, I was kind of smiling to myself before when you mentioned the words, you know, asset bubble or speculative bubble. Could you imagine what would happen in the markets if those words ever crossed Alan Greenspan's lips?
JONES: No, this time they would be listened to because there is a sense, I think, that at least the market's getting a bit over its skis here and certainly as we have come into the new year.
MARCHINI: Mr. Greenspan's great power over the market seems to have him muzzled. Is there anything short of scaring investors to death that he can do to tone things down a bit? He sure can't raise interest rates.
JONES: Well, again, jawboning or talking about it didn't work back in 1996. He's not going to raise interest rates. There's one small thing, but only I seem to be talking about it, stock market margin requirements, which haven't been changed, I think, since the 1970s.
MARCHINI: Fifty percent, right?
JONES: Fifty percent. It only applies to one percent of the trades, but symbolically because individuals trading directly in the market isn't where the big action is obviously with mutual funds and all the rest.
But I do think that symbolically that might be something the Fed should think about. Maybe that's an in-between move. They are not going to raise interest rates.
The one thing they will do, Deborah, is wait longer before they cut rates this year. That will be the surprise to the markets and that's probably what Greenspan is going to imply in his upcoming remarks on January 20.
MARCHINI: Is there a lot of margin debt out there on the part of individual investors?
JONES: That's a almost impossible thing to figure out, how many people used their credit card to speculate in the stock market. There's some hints I've seen here and there. It's too difficult to say. But, again, symbolically, it might be an in-between step for the Fed. The only trouble is I think I am the only person talking about it.
MARCHINI: No, I bet you Alan Greenspan's thought of it. But, you know, I don't have any sideline on what he's thinking.
All right, your basic bottom line then on this is: Don't look for a cut in interest rates for a good long time.
JONES: And that's right. And one other thing, Deborah. Long-term treasury rates came down from about five and three quarters around the middle of last year 1998 to five percent.
We have… backed up now because of a strong economy, heavy corporate supply and some other things. We may stay in that five to five and a half percent range for awhile. Maybe those rates will stabilize too and cool things down.
For now, though, the economy's strong, long-term rates are high and the Fed's not going to ease any time soon. 
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