Greenspan's Rallying Cry: Separating Sense From Nonsense

Stocks' winning streak ended today, as the S&P 500 (SNPINDEX:^GSPC), and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES:^DJI) both declined 0.2%. I'm highly skeptical concerning technical analysis, the pseudo-scientific discipline which seeks out patterns in price and volume data and ignores all fundamentals. Nevertheless, I have to admit that the S&P 500's Oct. 2007 record (nominal) high is proving remarkably resistant to this rally. Today will mark the sixth consecutive day on which the index closes within 1% of this level (it has not crossed it on an intraday basis, either.)

"Irrational exuberance" -- then and now
It's almost as if traders are skittish about crossing into uncharted waters; that would be odd, as I have yet to see a "here be dragons" warning beyond 1,565.15 on my S&P 500 price graph. If Captain Greenspan were still piloting this ship, surely we would have motored right through these waters by now. "Irrational exuberance is the last term I would use to characterize what is going on at the moment," he told CNBC morning, adding that this bull market has "still got a ways to go as far as I can see."

Option traders must have heard his reassuring words; despite stocks' decline today, the VIX Index (VOLATILITYINDICES:^VIX), Wall Street's fear gauge, was flat on the day, closing at 11.30. This ultra-low level is not uncharted waters per se -- we are at the threshold for the bottom 3.5% of values going back to the Jan. 1990 inception of the index -- but it is the equivalent of highly unusual meteorological conditions. (The VIX is calculated from S&P 500 option prices, and reflects investor expectations for stock market volatility over the coming thirty days.)

It's not clear why one should listen to Mr. Greenspan when it comes to the stock market's valuation, as his record on that front is hardly unblemished. It turns out that he was probably right when he made his most famous "call," famously referring to investors' "irrational exuberance" in a speech on Dec. 5, 1996. Indeed, from that day's close through today, the S&P 500 has risen less than 2.3% on an annualized basis, after inflation, which is significantly less than the long-term historical average. Oddly, though, when he delivered that speech, stocks were only about one-fifth more expensive than they are today with regard to their cyclically adjusted earnings.