Let me explain. As I see it, there are myths and there is reality. Anyone who believes that Alan Greenspan is a great and powerful and all-knowing wizard is into myths. He’s not the Mighty Oz. He’s just the guy behind the Federal Reserve Board curtain, pulling levers and poking buttons, hoping everything turns out right. Sure, the headlines blare that he raised interest rates and the stock market tumbled. But check a few interest-rate databases, as I had the excruciating pleasure of doing. Then you’d see that rates had already risen and that, rather than leading the pack, Greenspan was rushing to catch up.
‘0ff the record’: Which brings us to the stock-market myth. Despite last week’s debacle in tech issues and the Thursday bloodbath that spattered almost everyone who owns stocks, the myth holds that the overall market is still as strong as a stampeding bull. After all, the Dow Jones industrials and the Standard & Poor’s 500 are up about 4.5 percent since Jan. 1, translating to an annualized 18 percent gain. The market’s in its third straight great year, right? Wrong. Check the numbers that Birinyi Associates produced for me, massage them a tad–and you discover that the entire gain for the year comes from a mere 50 stocks. The rest of the market is down for the year, not up. Has the long-awaited bear market finally arrived without anyone noticing? In a word: could be.
Let’s go a bit deeper into the details, which are really interesting. Greenspan first. If he were to tell us what’s really going on (about as likely as the Easter Bunny’s holding a news conference on the White House lawn), he’d acknowledge that while the Fed is a big player, it doesn’t control the interest-rate game. Consider an exchange Greenspan had with NEWSWEEK’S Rich Thomas at a party a few years ago. Thomas complimented the Fed chairman on having dropped a few pounds, and asked: “Is it from chasing the long-term bond rate or dodging it?” Greenspan burst into laughter, Thomas recalls, then quipped, “That laugh you heard is off the record.”
Now, everybody knows that nothing Greenspan says (or does) is really off the record on Wall Street. But we don’t need the head Fed guy to tell us that the world’s financial markets are so large, so free from control by any government and have so many players that the Fed follows markets more often than it leads. By the time Greenspan announced, on Tuesday, that he was hiking a short-term rate that the Fed controls, the markets had in fact already moved. What’s more, long-term rates (which the Fed doesn’t control) have risen sharply. The rate on 30-year Treasury bonds ended the week at 7.1 percent, up from 6.6 percent at the beginning of this year and up from 5.9 percent at the beginning of 1996. I mention this because while all interest rates matter, long-term rates matter more than short ones. They determine what companies pay for long-term financing and what most homeowners pay for mortgage loans. And the higher long-term rates go, the more attractive bonds become relative to stocks–and the weaker stock prices get, at least in theory.
Greenspan’s goal last week was, clearly, to stop what he considers “excessive” speculation in stocks. He’s also worried about the fact that bank lenders have loosened up on credit standards, and that junk-bond investors, having forgotten that junk went belly up a mere seven years ago, are getting a tad frisky and financing more deals than they probably should. The rate hike, while not affecting bank credit standards or junk bonds, is a form of subtle muscle-flexing. In hindsight, it probably would have been better for Greenspan to have launched this campaign last summer, but let’s get real. President Clinton was running for a second term, and Greenspan was up for renomination as Fed chairman. You don’t get to head the Fed by undercutting the president when he’s running for reelection.
All this said, if the stock market tumbles, it won’t be because of Greenspan. Look closely at the numbers, and you will clearly see that the last few years’ exuberance began leaking out of stocks long before he flapped his lips in public last December. To be sure, the Dow and the S&P 500 have risen this year. But the prices of most U.S. stocks have fallen. How do I know? Let’s start with something called the Wilshire 4500 Index. This index includes the 7,000 stocks in the Wilshire 5000 Index, less the 500 S&P stocks. (Yes, the Wilshire 5000 has 7,000 stocks. Wilshire continues to call it the 5000 for reasons of marketing and sentiment.) The Wilshire 4500 is down 1.9 percent for the year, so the non-S&P 500 market is down.
Massage the numbers that Birinyi Associates churned out for me last week, and it looks like the 50 biggest S&P stocks accounted for virtually the entire gain the S&P 500 has shown this year. Without those 50 stocks, the 500 is flat, or maybe up half of 1 percent. Drop the 100 biggest stocks, and the remaining 400 are down. In other words, every stock index except the S&P 50 is down for the year.
This continues the pattern set last year, where the biggest S&P stocks rose much more than other stocks. You can see the gory details in the chart accompanying this story. (The Dow industrials are up sharply because most of them are big S&P stocks.) This strange, skewed market clearly owes a lot to the indexing mania. As you know, indexing–trying to mimic the S&P 500–is today’s market fad. The S&P is what’s called a market-weighted index. The higher the value of a company’s shares, the more weight that stock has in the S&P index. GE counts for 2.81 percent of the index; Armco Steel is .007 of 1 percent. So when you buy an S&P 500 index fund, $400 goes into GE for every dollar that goes into Armco.
Self-fulfilling prophecy: As I’ve written in previous articles, indexing is becoming a self-fulfilling prophecy. The better the index does relative to the rest of the market, the more attractive index funds become. And the more investors buy index funds, the higher the stocks in the index go. The Birinyi numbers show that we’ve finally reached the point where the indexing tail is wagging the market dog.
I think it’s a pretty good bet that Alan Greenspan will keep on raising rates for a while. I also think it’s a pretty good bet that the disparity between the 50 biggest S&P stocks and the rest of the market can’t go on indefinitely. Forget the talk you hear about these 50 companies being so great and so well managed that you can’t overpay for their stock. Trees don’t grow to the sky, as goes the old chestnut; neither do stocks forever rise. To think otherwise is nonsense. Better to believe in the Easter Bunny.
