Greenspan rocks world stock markets

Federal Reserve chairman warns of share price bubble
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The Independent Online
Stock markets around the world yesterday fell sharply and London closed with its biggest one-day fall in four years after what appeared to be a deliberate attempt by Alan Greenspan, chairman of the US Federal Reserve, to prick the bubble of soaring US share prices.

Mr Greenspan's warning of the dangers of "irrational exuberance" in stock markets at first raised the spectre of Black Monday in 1987 and at one stage wiped more than pounds 35bn off the value of shares in London.

But by the end of the day his intervention appeared to have done no more than cool the fever of the last six weeks in US markets, though it caused severe damage to share prices in the rest of the world as dealers waited in trepidation for the New York opening.

The FTSE 100 index, after plunging 168.5 in morning trading in London, later closed 88.2 points down at 3,963, wiping pounds 15bn off the value of Britain's largest companies and pounds 20bn off the market as a whole.

The market was also hit by concerns about the Government's loss of an overall majority.

One senior City fund manager said: "I think it is an overreaction. It could bounce next week."

But Tony Dye, the fund manager at PDFM who has become famous for his bearish views, took the slide as confirmation that the markets are badly overvalued.

In New York, the Dow Jones industrial index appeared to be going into free fall for a while, plunging 143.8 to 6,293.24 shortly after the opening.

However, reassuring US payroll figures - showing an increase in the US employment rate from 5.2 per cent to 5.4 per cent - helped it recover to a loss of 55.16 points at 6,381.94, by the close in hectic trading. The payroll figures helped ease concern that Mr Greenspan might be ready to raise interest rates. Joseph Stiglitz, White House chief economist, also said the markets were "over-reading" Mr Greenspan's remarks.

A 50-point fall in the Dow took it back only to its level in mid November, when the latest upward movement in share prices was in full swing, adding more than 500 points to the index in the three weeks after the presidential election. The Dow Jones industrial index has risen more than 24 per cent this year after rising by one third last year.

Mr Greenspan's key remark was: "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?"

This was in the context of a discussion of whether a collapse in a financial bubble damaged the real economy and of the extent to which monetary policy should take account of asset prices such as bonds and shares.

He said: "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 he made clear that central bankers nevertheless needed to be wary about asset price bubbles.

Economists have made an industry out of analysing the comments of a man who told a business audience some years ago: "If I've made myself too clear, you must have misunderstood me." His apparently oblique remarks are never off the cuff and invariably hold a carefully thought-out message for the markets.

One dealer in London said: "Greenspan sent a clear message to the markets - `Gentlemen, you are overdoing it, restrain yourselves.' "

The share price falls followed the sun round the world, beginning with the largest one-day fall in Tokyo this year, where the Nikkei was down 667.2 to 20,276.7. The sell-off spread west to Hong Kong, where the Hang Seng was down 388.83 to 13,102.73, followed by a collapse in prices in Europe.

In London the volume traded was low, confirming that much of the fall was a precautionary marking down rather than a panic.

Signs that British manufacturing industry was continuing to emerge from recession came with official figures yesterday showing that output rose 0.5 per cent in October. The growth was higher than the market was expecting, strengthening the hand of those calling for further interest rate rises.

New York analysts suggested that Mr Greenspan may have been driven to make the comments because of a tough dilemma now facing the Fed over whether it should raise interest rates to guard against inflation and help burst a market bubble that it considers risky for the economy, or lower them to reignite growth, which is showing signs of slowing.

Few on Wall Street expected however that Mr Greenspan's comments alone would lead to anything more than a modest share correction.

"We are not overvalued by any stretch of the imagination," said Joe Battaglia, an analyst at Gruntal.

By contrast, Robert Shiller, a Yale University economist and occasional adviser to Mr Greenspan, suggested that the Fed chairman had taken a historic step in signalling his anxiety.

Comment, page 21

Market Report, page 22

The London Stock Exchange yesterday set 20 October next year as the date for conversion to the new order-driven trading system for the largest stocks. The Exchange said the date was "challenging but achievable" and the timetable included a series of milestones at which progress would be monitored.

The new trading methods are computerised and automatically match buyers and sellers, replacing the market makers who now hold shares and set prices.

But no date has been set for extending order-driven trading to the rest of the market, which will depend on experience with the largest stocks.

The launch will be preceded by extensive practical simulation and testing throughout the market, the Exchange said. The target date is to be confirmed three months ahead of implementation in the light of progress at the time.

The timing will give the market a full nine months preparation after the final specification for the new service has been published. The revised rules will be published later this month.

What they were saying yesterday

"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?"

Alan Greenspan, Federal Reserve

"What do I think of the market? The same as I thought three months ago, six months ago, nine months ago and a year ago."

Tony Dye, head of investment at PDFM

"I warned a Federal Reserve meeting on Tuesday that the S&P 500 was trading at just under 19 times earnings and that's where the market peaked in 1968, 1972 and 1987."

David Shulman, chief equity strategist at Salomon Brothers

"The markets are really spooked. It will be hard to regain the confidence of a few days ago."

Bill Westgate, vice-president at HSBC Securities in London

"I think what happened is Greenspan is trying to talk the market down."

Hildegard Zagorski, market analyst at Prudential Securities

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