GameStop. Dogecoin. This 2021 stock market rally has one Federal Reserve Governor issuing a warning here:
"Asset prices may be vulnerable to significant declines should risk appetite fall"
Why? Some see such a warning as very necessary when looking at certain stock prices like GameStop (running from $30 to $400 and back to $40 in a couple weeks) here.
Back heading into-- still 3 years before the "tech stock bubble" of the late 1990's would burst. December 5, 1996 to be exact. The stock markets had been running up for a solid 2-3 years.
Long-time, popular Federal Reserve Chair Alan Greenspan issued, basically, a warning about stock prices. Maybe a warning just like the one today.
Saying investors were getting a little too optimistic. He called it "Irrational exuberance." Greenspan was considered a Godfather of finance at the time. He had a near-cryptic way of speaking. Like, you knew what he said, but he would come around at saying it. He was not direct; he preferred-- you could say-- an intellectual-esque, round-a-bout way of making his points. What stood out was the rare, catchy phrase within the broader message:
"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?" - (emphasis added) full text here
Translation: investors see less risks to the economy and little risk of inflation. So they are paying up for stocks. Which is generally warranted based on past correlations between inflation and corporate earnings. However, at some point does the reduced perception of risk and the rise in stock prices become... irrational? And thus subject to a big drop. Take this warning because Japan say a rapid 50% correction in their stocks and the stocks didn't even recover even 7 years later. And Japan stock prices are only now even approaching the possibility of reaching 1990 prices! Long-term Japan Nikkei stock index chart here.
So what to make of Brainard's (learn about her here) remarks? First, Greenspan's comments did lead to some of a sell-off in stocks for a couple weeks. But it was minimal. He was way too early in his call about stocks. Is Brainard also like 3 years early? Who knows. Probably early, but probably not that early. But will there be "significant declines"? Does the Federal Reserve know something? It would be wise to be open to listening and do your own research-- ie. take the warning into serious consideration and make sure you aren't over exposed to risk... especially with money you need. Also, tying the comments of Greenspan and Brainard together. U.S. investors today couldn't even imagine the scenario that has played out in Japan. What if this general timeframe today is roughly a top that could last for 30 years? Could you imagine if the Dow Jones Industrial Average (DJIA)-- currently above 34,000-- had declined a bunch and was only recovered to 26,000 in 2052? 2052.
