The collective heart attack in the world's stock markets earlier this month in response to some mildly adverse remarks by Federal Reserve Chairman Alan Greenspan suggests how nervous investors are in the wake of the spectacular run-up in U.S. stock values since last summer. Greenspan, after all, didn't even say that the markets were too high; he merely said it is sometimes hard to tell. The market made a sharp recovery the Monday after Greenspan's remarks, but experienced choppy waters most of the week, with the net direction down.
So Greenspan's question still hangs there: How high is too high? By almost all standard measures--such as the ratios between stock prices and corporate earnings, or stock prices and corporate assets--the market is at historic highs. Does that mean we are poised for a devastating correction? A 1929-style sell-off that presages a major recession? The Japanese "bubble economy," after all, blew up more than five years ago, and Japanese business still has not recovered.
Anything can happen, of course, but American doomsday scenarios do not appear at all likely. Stock prices probably are running somewhat ahead of economic fundamentals, and there is no reason to expect a continuation of the 20%-30% annual gains that stock-market investors have learned to take for granted. But the American economic outlook for the rest of the decade is unusually benign--it's a good time to be president--and the inevitable market corrections are likely to be fairly mild and not terribly prolonged.
The most recent investor wailing is also more than a little overdone. When the market was in the doldrums last summer, investors would have been overjoyed at the prospect of the Dow Jones industrial average closing the year above 6,000. Even after a nasty week, the Dow ended still more than 20% higher for the year. Hundred-point drops sound dramatic, but they really meant something 15 years or so ago--when the Dow was hovering at only about 1,000. Financial pundits sometimes talk as if the stock market is the same as the real economy, but it is not even a good proxy for it. Stock prices are epiphenomena, like froth on a river, and market values and economic fundamentals can move in different directions for extended periods of time.
The growth rate of the U.S. economy during the 1970s, for example, was not that bad--about 2.8%, on average, after inflation, or about the same as it is now--but the main stock-market index, the Dow, did not go up a nickel's worth the entire decade. If you factor in inflation, which was high in the 1970s, the average stock-market investor got killed. Market boosters like to advertise the stock market's steady 10% annual average gain since 1926, but the averages conceal long periods of sluggish growth punctuated by periodic sharp upward price swings, with almost all market gains concentrated in just a few months each year.
So why are the 1990s likely to be different from the 1920s and the 1970s? There are, in the first place, almost no valid points of comparison between the 1920s stock market and today's. In the 1920s, there was no Securities and Exchange Commission, no disciplined accounting standards, a far less broadly based market, rampant insider trading and, as in the case of the "trust" pyramids, market prices that were wildly out of sync with underlying values. Except for the occasional frothy new offerings, which are always widely reported, none of those elements is present today.
The comparison with the 1970s is more relevant. Despite the relatively respectable official growth rate, there was a widespread sense that the economy was slipping its moorings. There were oil-price shocks, angry queues at the gas pump and skyrocketing inflation. The baby boomers were flooding into the job market, and the average skill and experience level of the work force took a decisive dip downward. The Third World debt crisis wreaked havoc on banks' balance sheets, while high interest rates choked off long-term investment. The sickening realization that America had lost industrial leadership to the Japanese and Europeans in everything from cars to computer chips was slowly spreading through flagship industries. The growth statistics had an air of falsity, merely measuring how fast we were eating our seed corn.
Twenty years later, the picture is radically different. The population is stable, and the boomers are in their most productive, high-saving years. After a painful decade-long restructuring, U.S. companies have regained leadership, or at least achieved parity, in most important industries. The official inflation and savings data probably understate how much improvement there has been. Money is flooding into the stock and bond markets; interest rates are as low as they've been in years, and America has taken to lecturing the Europeans and Japanese about their budget deficits.
It won't last. But barring a catastrophe--like a nuclear war in the Middle East that irradiates the world's oil reserves--the good times probably have another five or 10 years to run. (The fabled Clinton luck still holds.) There may still be occasional shallow recessions, but the next really wrenching adjustment period will not arrive until the boomers enter their 60s and 70s, and America is forced to convert to a retirement-oriented, health-care-based economy.
The remaining good times, of course, do not guarantee that stock prices will keep on rising. The recent price run-ups, for example, as Greenspan hinted, may have been much too fast, and the market may suddenly correct to some lower level, or simply mark time at current prices for an extended period.
Investors will surely scream bloody murder if they get merely decent returns instead of extraordinary ones. But there seems no plausible reason to expect a Japanese-style "bubble economy" market implosion. Market averages can drift far away from economic fundamentals, but, over the long term, as long as the fundamentals continue to be benign, the overall direction is still likely to be up.*