February 3 - Of Course Greenspan Targets Stocks: He Just Can't Aim

Greenspan has tried his hardest to shoot equities down, he just has bad aim.  Why he doesn't target margin rates is  baffling, but with another large rally he may be forced to expand his repertoire; verbal warnings and interest rate hikes have not ended the equity mania which is one of, if not the most important element which keeps  this economy hot.

As the markets putted  through yesterdays ¼ point rate hike with ease, a growing hum heard across Wall Street was that the Fed is not,  nor has he ever been targeting the stock markets.  One analyst actually went so far as to say  the very idea was "ridiculous".   Ridiculous?…I think the thought is at least a plausible one, isn't it?
Let us not forget that these same analysts are the ones which assume stocks will not collapse since  the Fed is so "on the ball".  Why is cutting rates to ensure stocks don't crash any different than raising rates to curb rallies or control the wealth effect?

The problem with the notion that the Fed  doesn't take into account high stock prices as an economic indicator in deciding monetary policy is that stock prices can and have impacted many if not all of the leading economic indicators.   Therefore the  fed in an indirect manner has to scrutinize equity prices as he would any other statistical reading in order to predict possible imbalances and dangers inside the economy.

Stocks & Greenspan

 Do rising stock markets help increase productivity among other things?
Greenspan, Oct 29  "A whole new set of profitable investments raises productivity, which for a time raises profits--spurring further investment and consumption."

Are higher interest rates supposed to cool down stock markets and the economy?
Greenspan, Nov 2 "Stock prices and existing home sales are somewhat correlated, a not altogether unexpected result, because each is affected by interest rates and presumably the gains from each help finance the other."

Are earnings going to justifiably keep increasing?
Greenspan Aug 27  "bull stock market…accentuating some accounting difficulties that tend to bias up reported earnings. One is the apparent overestimate of earnings that occurs as a  result of the distortion in the accounting for stock options"
 "Similarly, the rise in stock prices, which reduces corporate contributions to pension funds is also augmenting reported profits. These upward  adjustments in reported earnings, of course, are a consequence of rising stock prices and, hence, may not be of the same dimension in the future."

Do stock markets influence consumer confidence?
Last October  stocks were rattled for most of the month and Wall Street suffered its worst 1 week loss in 10 years (Oct 11 - Oct 15)
The expectations subindex followed stocks like a puppet dropping to 101.1 from 106.2 (the lowest  ready in 1999)
 
But Tell Us What you really think Greenspan…
Greenspan,  Oct 14:  "Whether Dutch tulip bulbs or Russian equities, the market price patterns remain much the same.".  (The Dow lost 2.6% the day after this comment)

So, does Greenspan look at stock prices?
Just take a look back to when the markets started rallying after he raised interest rates on June 30^th.  On July 22 a perturbed fed stated "Euphoric stock prices" and  "Growth rate irrelevant", he also told us another rate hike was coming in August  even though inflation was thought to be dead.  Were these comments by Greenspan prompted by rising stock markets?  Absolutely!
After the August rate hike Greenspan waited four days and then spent an entire  speech eluding to stock market speculation.  Early on in the speech he said "I plan to address some of the problems that arise in  evaluating the prices of equities.".   32 bearish paragraphs later he closed by saying "Accordingly, we have little choice but to confront the challenges posed by these questions if we are to understand better the effect of changes in balance sheets on the  economy and, hence, indirectly, on monetary policy.".

Perhaps the fed doesn't directly target stocks by entering  the market short or by raising a full point when he feels like it but he does target them as possibly hazardous and speculative as history dictates.

Was Greenspan thinking about Abbey Cohen when he said this?
"Some analysts perceive that information technology has permanently lowered equity premiums and, hence, permanently raised the prices of  the collateral that underlies all financial assets".

Was he thinking about 1929 when he said this?
"valuations are shaped in part, by the economic process itself. But history suggests that they also reflect waves of optimism and pessimism that can be touched off  by seemingly small exogenous events."

Closing

Greenspan is always investigating the evolving relationship between rising stock markets and the economy and has arrived at one conclusion; danger.There is a grave danger in stock prices being so high with so many  Americans exposed to them.  When Greenspan discusses and acts on these dangers he hopes like any good fed that they will pass, but they have not.  So regardless of inflation if stocks continue to  dramatically rise Greenspan will continue to raise interest rates.
People who remember the "irrational exuberance" comment from December 1996 keep laughing today but remember Mr.Greenspan isn't some Wall Street head  making money off of commissions while pumping his own interests, he is an honest man who has shot many warning arrows at these markets for the benefit of the economy and overall investor health.  How long the  bull-armor holds up is the only question left to ask.  If the fed can enter the markets during a crisis and buy futures (talked about) then they better be willing to act if another rally takes flight.   Greenspan was back on target yesterday after a vacation in late 1999 due to Y2K.

 

Reading Materials

Jan 31, 2000 (Federal Reserve Bank Of New York) PDF File
Does Buffer Stock Saving Explain the Smoothness and Excess Sensitivity of Consumption?

July 1999 (FRBNY)   PDF File
How Important Is the Stock Market Effect on Consumption?