In December 1996, Alan Greenspan gave his warning that Wall Street was showing “irrational exuberance”. Even at the time, it was noted that Wall Street shrugged off the warning, although it came from the Chairman of the Federal Reserve Board. However, I wrote a piece about it in The Times, which was given the prescient heading “Wall Street Will Crash”. That article was published on December 12th, which now seems an age ago.
I quoted an American analyst, Michael Belkin, in support of my argument. He had observed that “by most traditional yardsticks, the U.S. market is exceedingly overvalued. I recently unearthed excellent dividend yield data going back to 1871 in the National Bureau of Economic Research database. The current 2 per cent dividend yield is the lowest in 125 years (the average is 4.5 per cent)”.
When I was writing, the Dow Jones industrial average stood at 6,500, around its all time high. It has had extreme fluctuations in the last few weeks, but on historic yields it has not completed its correction. Since 1996 it has experienced two bear markets, the present one, and the crash of the dotcom bubble early in 2000. The present bear market is by no means over. The average period of bear markets in the 125 years before 1996 was surprisingly long. Even if one excludes the 18 year bear market from 1899 to 1917, on the grounds that it was distorted by the threat of war before 1917, the average length of bear markets, up to 1996, was about five years. In these bear markets the dividend yield could go very high: in 1873, at the beginning of General Grant’s second term, the dividend yield reached 8.5 per cent; in 1917, the year that the United States entered the First World War, the yield peaked at 9.3 per cent; in 1932, the slump year in which Franklin Roosevelt was elected President, it reached 9.6 per cent; Pearl Harbour took it to 9.5 per cent. The recession of 1982 – a nasty one – only saw the dividend yield got to 6.2 per cent.
These figures cannot be made the basis for any remotely reliable forecast, but they do suggest two conclusions. The first is that the bear market on Wall Street is entirely likely to last for as long as five years. Of course, the recession in the economy could be shorter, though there is no guarantee of that. The second is that we may have to expect a relatively long period of high dividend yields and high price-earnings ratios.
House prices, which have played so large a part in this recession, have not completed their correction. The problem of American (and indeed British) debt has not been resolved. The first steps have been taken to reorganise the banks, but that process is far from complete. Consumer debt and mortgage debt are still excessive and unstable. The one favourable factor is that Governments are trying to reflate in a depression, whereas President Hoover deflated in a recession. At least that vital part of the Keynesian Revolution has become a normal element of official thinking.