Dancing to the Fed’s bullish tune

IT has been the case, and will continue to be so for the lifetimes of the world’s seven billion people, that Wall Street leads where other markets follow. It has become the bellwether for investors everywhere.

In modern times, as is well known, the 1929 crash led to years of depression in the world. In the US, soup lines formed each day for millions around the country whose sole meal of the day it would be.

Meanwhile, in Boston, the son of Irish immigrants, Joseph Kennedy, made some money based on tips from a shoeshine boy. He then concluded that if shoeshine boys were making money in the market, it was time to bail out. Not only did he do that, amassing millions when a million was worth a great deal more than it is now, he also went short, setting the financial foundations for the great Kennedy dynasty in US politics.

He also dabbled in smuggled booze, capitalising on the ridiculous 1920 Prohibition Act on the consumption of alcohol passed by

❛ The market will keep hitting its highs until the stimulus reverses itself

the senate and congress over the veto of president Woodrow Wilson. Prohibition gave rise to Mafia power, corruption and violence. Let’s hope our looming advertising ban on booze doesn’t have a similar outcome.

Of course, if we suffer a market crash, rather than a modest and, be assured, inevitable correction, the booze business should do quite well out of us as we drown our sorrows, advertising or not.

In December 1996, Alan Greenspan coined a memorable phrase in his warning remarks on what appeared to be an endless bull market. “Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets,” he said. “We can see that in the inverse relationship exhibited by priceearnings ratios and the rate of inflation in the past.”

Shortly thereafter, the markets — led, of course, by Wall Street — entered into a sustained and sharp decline, far more than a correction.

“But how do we know,” he asked, “when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

The S&P 500 shot up 24% this year, looking likely to achieve its best yearly rise since 2003, prompting a cynical blogger to take aim at Greenspan this week.

“Alan Greenspan, the guy who saved the world right up until we realised he was responsible for destroying everything, says stocks are headed up. PANIC,” he wrote.

“Alan Greenspan, 2005: ‘The resolution of our current account deficit and household debt burdens does not strike me as overly worrisome.’ (Housing bubble pops and everything goes to hell.)

“Alan Greenspan, 2013: ‘In a sense, we are actually at relatively low stock prices . . . (the market has) gone up a huge amount, but it’s not bubbly.’ DEAR GOD.”

For the bulls, some comfort can be had from the comments of Leon Cooperman, CEO of Omega Advisors. Last week he pointed out on CNBC that the historical priceearnings multiple for the market is 15, and that is with an average inflation rate above 3% and the 10year treasury yield at 6%.

Now, however, the S&P 500 trades at a 13.5 price-earnings ratio with inflation rates between 1% and 2% and the 10-year treasury yield at 3.49%. US corporations are sitting on trillions of dollars in cash while curbing labour and other costs.

The consensus appears to be that the party will go on as long as the Federal Reserve continues its stimulus policy, which keeps a lid on interest rates and lifts demand in the economy. Bill Mann, of the quaintly named Motley Fool Asset Management, supports this: “The central bank has decided they will reward risk behaviour and that’s what we’re going to get. The market will keep hitting their highs until the stimulus reverses itself.”

Don’t say you weren’t warned.