Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Greenspan: To kill or not to kill? - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Feb 18, 2000

    Greenspan: To kill or not to kill?

    Mr. Alan Greenspan, Chairman of the Federal Reserve, the powerful central bank of the world's most powerful economy is in an unenviable position of trying to calm what has clearly become a runaway economy. In late 1998, Mr Greenspan had to cut interest rates in the face of the collapse in Russia and the losses of LTCM, a hedge fund that made losing bets. Since then Mr. Greenspan has been trying to cool the stock market with interest rate hikes: gentle but persistent. So far his soft approach has been a failure and the NASDAQ, the barometer of frenzy in technology stocks closed at another record on February 17 on record volumes.

    There are three major ingredients that cause share prices and stock markets to rise:

    1. past profits of the company,
    2. expectations for the future profits,
    3. alternative assets one can invest in for a risk-reward relationship

    Traditionally, central banks are concerned about inflation and adjust interest rates to account for future, expected inflation. But now Mr. Greenspan may have to use interest rates to discipline financial markets that have flown because of easy money and low implied risk. By controlling the rates of interest (the cost of capital) in the US economy, the Fed is sending out a signal not only on its own macro concerns of inflation (a responsibility of every central bank) but also on the level of risk attached to any investment alternative.

    If interest rates are 5% on risk-free government bonds, then any other asset must give a better return for the higher risk that it has relative to the government bond. As Mr. Greenspan increases interest rates in the US, he is not only fighting inflation (wage costs and oil prices that are on the rise) but is also setting a benchmark for the rate of return on all risky assets. But Wall Street does not seem to be bothered by Mr. Greenspan's desire for a soft landing - the ability of a central bank to gently convert a roaring economy into a tame and alive cat. Every marginal hike in interest rates is seen as a victory for the risk taker and a loss for the cautious (some would argue sensible) investor. To kill inflation in the early 1980's Paul Volcker, the then Chairman of the Federal Reserve saw interest rates rise to 21%. Mr. Greenspan, while speaking of irrational exuberance for four years, has done little to kill the rocketing valuations on Wall Street.

    Despite all the positives of technology and the increasing use of the internet, there are limits to the relationship between a business and the valuation of the business. The traditional valuation measures of Price-to-Earnings and Price-to-Cash Flow have given way to more aggressive ratios such as Price to Sales. My guess is that many of these ratios have been created to justify high valuations rather than be the reason for those high valuations. When nothing ordinary fits, the extra-ordinary is called upon to rationalise and to justify. Many argue that valuations of technology businesses have been stretched beyond recognition. Mr. Greenspan is aware of this and even made a reference to one internet company raising capital that said it had no business and no business plan but intended to develop one.

    And history is full of examples of business wonders that did not translate into real profits for everyone. As Warren Buffett pointed out in a recent article not many made money on previous technological revolutions that created hundreds of auto airline, and electricity companies. At the height of Japan's bubble, I have been told, the Emperor's Palace Grounds in Tokyo was worth more than all of Canada. We saw that in India with our own real estate bubble where at one point in time the value of property in Bombay must have been a significant portion of India's GDP. And we have had our share of finance and leasing companies that promised us upwardly, mobile returns.

    Bubbles ultimately burst. Mr. Greenspan has the unenviable task of killing the frenzy in the technology sector in the US (that has now spilt over to all parts of the world) or going down in history as the central banker who was unable to stop a frenzied stock market from causing a major economic collapse.



    Equitymaster requests your view! Post a comment on "Greenspan: To kill or not to kill?". Click here!


    More Views on News

    Insider Leaks Equitymaster Stock Picks (The 5 Minute Wrapup)

    Jul 25, 2017

    Equitymaster HQ has been infiltrated. Valuable stock ideas have been leaked. Who's responsible?

    Raymond and Other 'For Profit' Companies Who Don't Care about Shareholder Returns (The 5 Minute Wrapup)

    May 27, 2017

    What happens when minority shareholders are short-changed in the normal course of business?

    Why Commission Driven Model In Mutual Funds Should Be Eliminated... (Outside View)

    Feb 15, 2017

    PersonalFN believes SEBI has taken a step back-apparently in the admission of it going overboard with the regulations.

    This Book Changed How I Looked at the World of Man and Money (Vivek Kaul's Diary)

    Aug 24, 2016

    And here's your chance to claim a free copy of this book...

    The Developed World is Dying because of Demographics, Debt, and Deflation (Vivek Kaul's Diary)

    Aug 12, 2016

    And Why India's demographic dividend could turn out to be a doubtful debt...

    More Views on News

    Most Popular

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    The Most Important Innovation in Finance Since Gold Coins(Vivek Kaul's Diary)

    Aug 10, 2017

    Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    Bitcoin Continues Stellar Rise(Chart Of The Day)

    Aug 10, 2017

    Bitcoin hits an all-time high, is there more upside left?

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms