Greenspan Just Gave A Dire Warning About The Market

Alan Greenspan is back in the news. The former chairman of the Federal Reserve is now 91 years old but still sounds just like he did 30 years ago when he burst onto the world stage. I’ve always found that he speaks in a reassuring tone, which was important back in 1987, when he was beginning his tenure at the Fed.

You see, in October of that year — just months after Greenspan’s nomination was confirmed by the Senate — the market suffered a major crash. While investors were reacting, Greenspan reassured the world that the Fed would be the lender of last resort, ensuring the financial system didn’t fail. In the end, Greenspan never needed to act because the stock market stopped its decline as quickly as it began.

Maybe the markets calmed down because Greenspan jumped in front of the news so quickly. We’ll never know what caused the panic selling to end but we know Greenspan continued to exert a calming influence on the markets.

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Even when he was bearish, his warnings of market excesses were delivered in a benign voice. In December 1996, he famously asked if traders were suffering from irrational exuberance. But his concerns were shrugged off at the time and stocks rallied for more than three years after that.

Although he was early, Greenspan was right. That makes his latest warning ominous. Given his forecasting track record, even if we don’t know when he’ll be proven right, he is likely to be right.

Greenspan spoke to Bloomberg this week and had an important warning regarding low interest rates:

#-ad_banner-#“By any measure, real long-term interest rates are much too low and therefore unsustainable. When they move higher they are likely to move reasonably fast. We are experiencing a bubble, not in stock prices but in bond prices. This is not discounted in the marketplace.”

He also explained what he believes this could mean for the stock market:

“The real problem is that when the bond-market bubble collapses, long-term interest rates will rise. We are moving into a different phase of the economy — to a stagflation not seen since the 1970s. That is not good for asset prices.”

As always, it is difficult to find flaws in Greenspan’s logic. The economy has stagnated since 2008, and interest rates are much too low. We know this based on history.

Inflation is low, but it has been this low in the past. In fact, the United States experienced a similarly low level of inflation in the 1960s, as the blue line on the chart below shows. However, at that time, the short-term interest rate (red line) was above the rate of inflation. That is a normal environment.

Today, interest rates are below the rate of inflation. When inflation starts to rise, Greenspan believes we’ll also see interest rates rise — and quickly. This would be analogous to what happened from 1966 through 1982. During that period, the rate on the three-month Treasury bill rose to more than 15%… while stocks traced out an extended bear market.

Greenspan is warning us that history is about to repeat itself. He has spent decades studying economic history, and it’s worth paying attention to his warning. In this environment, it could be best to avoid being aggressive in the stock market. Short-term trades in conservative stocks could be the safest way to generate income and gains for now.

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