Gary North

March 4, 2009

The S&P 500 closed below 700 yesterday. The market had tried to rally all day. It closed lower.

The MarketWatch headline read: S&P 500 Closes Below 700." The subhead read: "Wall Street extends losses, with S&P 500 Index tumbling below 700 for the first time since October 1996."

The headline writer forgot about price inflation.

Just for fun, guess how much have prices increased, officially, since 1996.

See if you're correct. Go to the Inflation calculator of the Bureau of Labor Statistics.

We forget. Headline writers forget.

The Greenspan stock bubble years are generally said to have begun in 1996. In a speech to the neo-conservative AEI in December, he said this:

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know 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? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.

That was the first time he used Robert Shiller's phrase, "irrational exuberance."

The S&P 500 was at 744 that day.

He created the conditions that led to irrational, exuberance. Then Bernanke inherited the mess.

Any poor soul who bought the S&P 500 in 1996 is down a third in terms of purchasing power. He has lost a dozen years, and he is in the hole. Dividends were barely enough to pay his no-load fund's fees.

Now he is 12 years closer to retirement. He has seen his dreams smashed. Still, he holds on. He is so taken in by "buy and hold" that he cannot exit a sinking ship. He dreams of a comeback. There is no evidence that he will get it, in dollars of stable purchasing power, before he retires.

The typical stock salesman tells his clients to hold on. He will starve if they stop buying. He will not tell them the truth.

People believe nonsense, year after year. The market falls, and still there is no climactic sell-off in shares. The stock market grinds lower, erasing any prospect of recover to 1996, yet hope does not fade.

The grinding process is a killer. People will not call their brokers and sell. The longer it goes on, the less likely a younger generation will ever buy stocks. They will remember what happened to their parents, just as my parents remembered what happened to theirs. They never bought stocks. It was my generation that bought. This generation has now reaped the grim results. But still most of them hope against hope.

Let Buffett buy. Let him dream. He will be dead before they get back to 1996.