Booms, Bubbles and Busts in US Stock Markets

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In the US stock market things have changed a great deal since the heady days of the 1980s and we are now entering an era of profound uncertainty, with most analysts predicting trouble ahead. Indeed, the alarming decline of the NASDAQ shows no sign of abating and the fear is that traditional industries will be the next to bite the dust. September 11th has only added to the gloomy mood.

A user-friendly overview of the inner workings of the US stock market, this book examines the current market conditions before looking back to the events of the past century - the Great Depression, the 1970s oil crisis, the party-for-the-rich atmosphere of the 1980s and the emergence of the new economy.

Book Cover 2
Half-Title 3
Title 4
Copyright 5
Contents 6
Figures 13
Tables 15
Foreword 16
Acknowledgements 19
Introduction 21
- From one bubble to another? 21
- Why the stock bubble? 21
- A unique set of circumstances? 22
- How absurd were valuations? 23
- Why did investors ignore warning signals? 24
- Why did the stock bubble burst? 24
- Why did Greenspan ignore ‘irrational exuberance? 24
- Greenspan and the markets 26
- The Fed’s enemy: inflation or deflation? 27
- How costly was corporate governance failure? 27
- What are the lessons from the 1929 bubble? 28
- Japan’s mess and deflation: what can the United States learn? 29
- The massive policy push: powerful enough to create sustainable growth? 30
- A bull or bear market rally? 32
- How fragile is the US recovery? 32
- Where from here? 32
1 The bubble era in US stocks 34
- Introduction 34
- Origins of the bubble 35
- Stocks versus bonds 37
- Why the stock bubble? 37
- Absurd valuations 40
- The bubble: geopolitical forces at work? 42
- The bubble: underwritten by a stable bond market? 44
- Debt, savings and switching 45
- Warning signals: why not switch? 47
- What of corporate earnings? 48
- Similarities with 1929 50
- Where from here? 51
- Conclusion 52
2 The great bull run of the 1990s 54
- Introduction 54
- Macroeconomic background 55
- The policy paradigm 59
- Dip and recovery: 1990–1 61
- The policy-induced correction: 1994–5 63
- The roaring Dow: 1992–3 63
- Up, up and away: 1996–7 67
- Correction and a major recovery: 1998–2000 72
  - A real bubble? 73
  - Financial perspectives 75
- Conclusion 76
3 Valuation methods and investment strategies 77
- Introduction 77
- Portfolio choice 78
- Diversification and risk 80
- News: economic or financial? 82
- Market efficiency 83
- Investing over the life cycle 84
- The fundamentals approach 85
- The contrarian strategy 87
- Serial correlation and mean reversion 89
- Investment strategies 91
- Financial fragility 93
- Expectations, trading and timing 93
- Conclusion 95
4 The bubble era 97
- Introduction 97
- Biases in the one-way street 97
- Where were the arbitragers? 104
- Old benchmarks and turning points 105
- Was it a speculative bubble? 106
- The ‘New’ new economy 107
- The 1990s: a deviation from fundamentals 108
- Wealth storage and far-sightedness 110
- Greenspan’s defense of the NASDAQ bubble 111
- Domestic origins of the boom 113
- Conclusion 114
5 The new economy 116
- Introduction 116
- Productivity growth and the stock market 117
- A rational bubble? 118
- Old questions and old answers 119
- The productivity slow down debate 120
- Sources of productivity growth 121
- The IT and communications revolution 123
- IT and communications: drivers of productivity growth? 126
- US government and productivity growth 127
- Productivity growth: how permanent? 128
- Productivity and the stock bubble 129
- Conclusion 130
6 Governance issues 132
- Introduction 132
- Market versus government failure 132
- Incentives and trade-offs 135
- What are the challenging issues? 137
- Wall Street in the 1960s: fresh challenges 138
- Past pressure for regulation 139
- The case of Enron 141
- A dangerous incentive structure? 142
- Regulatory reform and the Sarbanes-Oxley Act 143
- Conclusion 145
7 The Federal Reserve 147
- Introduction 147
- Ultimate objectives and trade-offs 148
- The yield curve 149
- The government environment 149
- America’s economic cruise speed: what guideposts? 150
- Diagnosis of imbalances 152
- Hitting targets: what policy mix? 156
- What economic indicators? 157
- Critics of the ‘Wrong Paradigm’ 159
- Canterbery’s Vatican paradigm 160
- Reputation and credibility of the Federal Reserve 161
- The caterpillar market and fear of the Fed 162
- Confessions of a central banker 163
- Is the Fed secretive? 164
- Conclusion 164
8 Shifting ground beneath the Federal Reserve 166
- Introduction 166
- Deregulation of the financial sector 167
- Financial product innovation 168
- Technology and innovation 170
- The effectiveness of monetary policy 173
- Target interest rates or monetary aggregates? 175
- Does money affect output? 176
- Channels of the monetary transmission mechanism 177
- Does money affect stock prices? 179
- Interest rates: how effective on output? 180
- Interest rates: what affect on stocks? 182
- Conclusion 183
9 Evaluating the Greenspan years: 1987–2004? 185
- Introduction 185
- Greenspan’s economic philosophy 186
- Greenspan’s background 186
- Greenspan and the markets 189
- Power to move the economy? 193
- Sifting wheat from the chaff 193
- Mistakes in the Greenspan era? 194
- Greenspan’s two flagships 197
- Flexibility: Greenspan’s hallmark 199
- Conclusion 201
10 The great asset price bubble of 1929 202
- Introduction 202
- Seeds of the bust in the 1920s 202
- Damage to the real economy 204
- Causes of the 1929 crash and depression 205
  - The Keynesian view 206
  - The Galbraith-Kindleberger view 207
  - The monetarist view 209
  - Financial sector disintermediation and balance sheets 210
  - Goods price deflation 211
  - Asset price deflation 212
- What were the triggers? 213
- What lessons have we learnt? 213
- Could history repeat itself? 214
- Conclusion 215
11 Lessons from Japan’s financial crisis 216
- Introduction 216
- Japan’s old growth strategy 216
- Weaknesses and seeds of destruction 218
- Macroeconomic challenges 219
- Policy levers 219
- Why the asset price bubble? 220
- Financial not economic constraints 222
- Japan’s asset price bubble: liquidity roots? 223
- What of the export growth strategy? 224
- Monetary policy failure 224
- Monetary transmission mechanism: clogged pipes? 225
- Fiscal policy failure 227
- Krugman’s insight 229
- Japan’s policy response: why so ineffective? 230
- Lessons from Japan’s financial crisis 231
- Flow on effects from Krugman’s solution 232
  - An appropriate policy response 233
- A multi-pronged approach to recovery 232
- Lessons from Japan’s stagnation 233
- Conclusion 234
12 The Asian bubble and crisis 235
- Introduction 235
- Some commonalities 235
- Financial origins of the bubble 236
  - Corporate sector leverage before the crisis 238
  - The roller-coaster of speculation 238
  - Crony capitalism and accelerated development 239
  - Financial sector failure: the fading heartbeat 240
  - Erosion of competitiveness 240
  - Foreign forces 241
- Excess liquidity revisited 242
- Why did the bubble burst? 243
- The Asian crisis: why so sudden? 245
- Stock market performances: post bubble 247
- Conclusion 251
13 US stock markets 252
- Introduction 252
- From one bubble to another? 253
- What of currency instability? 254
- The liberation of Iraq 255
- Geopolitical forces 256
- Synchronization and integrated markets 257
- Why the US stock rally? 259
- The powerful policy stimulus 260
- The US economic recovery: where from here? 263
- Lessons from the movie: Wall Street 264
- Conclusion 264
Bibliography 268
Index 274

Author's affiliation

David L. Western: Curtin University Business School, Australia

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