Bubbles Greenspan and the Significance of Dow 10,000

A moment of silence, please, for our fallen comrade, the Dow Jones Industrial Average…

Yes, it’s true; the beleaguered index fell through 10,000 yesterday to finish the trading session below where it stood last November. But yesterday was not the first time the Dow ever fell below 10,000. In fact, it was the 28th time since March 29, 1999 – the Dow’s very first close above 10,000.

When the Dow scaled 10,000 in March of 1999, the stock market had been rallying for several years already. Just five years earlier, the Dow had breezed through the 5,000-level. Therefore, almost no one doubted that 10,000 would be a mere stepping stone to 15,000…or 20,000…or yes, even 36,000, as James Glassman and Kevin Hassett infamously predicted in their 1999 classic: Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market.

But Dow 36,000 would have to wait awhile. Instead of continuing its vertical ascent, the Dow would spend the next eleven years tripping over itself. On twenty-eight separate occasions, the Dow would climb through 10,000…only to slip back below 10,000 sometime later. Each failed attempt produced more discouragement and fatalism than the time before. Stocks are supposed to appreciate over time, we are told – not to muddle along for years at a time. The Dow was supposed to blast through 10,000 in 1999 and never look back. It was not supposed to return to 10,000 as frequently as a “B-actor” to rehab.

What went wrong?

The short answer is: Alan Greenspan. (The long answer is also Alan Greenspan). The former Chairman of the Federal Reserve nurtured an epic financial bubble during most of his 19-year reign.

After slashing interest rates sharply during the early 1990s, Greenspan hiked them a bit in 1994, before cutting rates again between 1995 and 1998. The stock market tripled between 1990 and 1998. But here’s the interesting thing: when Greenspan hiked rates in 1994, the stock market struggled…and so did Greenspan’s popularity.

Greenspan did not regain his adoring followers until the back half of the 1990s, when he resumed cutting interest rates and stocks resumed their climb. But then he hiked rates slightly once again, as the stock market bubble reached its zenith in 1999. The bubble burst…and so did the aura of infallibility that had calcified around Greenspan’s reputation. Suddenly, he had critics again…and he did not seem to like it very much.

He had learned his lesson: He would never be unpopular again…no matter how many bubbles he would have to inflate or reflate. As the stock market bubble began bursting in 2000, Greenspan quickly sprung into action – replacing the stock market bubble with an even more magnificent housing bubble. Between mid-2000 and mid-2003, Greenspan slashed short-term interest rates from 6.5% to 1.0%. He implemented “emergency interest rates without an emergency,” as Jim Grant observed at the time.

The rest is history. The stock market rebounded, home prices rocketed and Wall Street bankers figured out how to convert junk mortgages into AAA securities. Greenspan is not to blame for everything, of course, just…almost everything.

What does this condensed and biased portrayal of history have to do with Dow 10,000? Just this: without easy credit, and the mania it spawned, Dow 10,000 would not have been possible. When the Dow first reached that magical level in 1999, the blue chip index was trading hands for about 28 times earnings – its highest valuation in 70 years.

Stocks were grossly overpriced. No doubt about it. Thus, to be an eager buyer of stocks in March 2000 was to believe that price mattered less than Alan Greenspan’s magic touch. Eleven years later, we have discovered that price matters more.

But don’t be discouraged. The Dow’s disastrous decade does not invalidate the theory that stocks are an excellent long-term investment. Instead, the Dow’s lost decade merely adds two corollaries to the theory: 1) Beware popular Fed Chairmen; 2) Price matters.