Back to the nineties
January 1996. Having raised its key interest rate from 3% to 6%[1], the US Federal Reserve (Fed) completed a brief cycle of rate cuts to 5.25%. In parallel with this movement, US growth accelerated and – after two years of stagnation – the equity market continued along the excellent trajectory of the previous year, 1995, when the S&P 500, dividends reinvested, rose by 38%. The flagship index of the US stock market closed 1996 with another rise of 23%, whilst the Nasdaq rocketed by 43%, bringing its rise over two years to more than 100%.
This broad overview has some similarities to today’s situation: sound growth; a central bank that has raised interest rates without provoking a recession and will lower them modestly; and a euphoric equity market driven by the technology sector on the back of major innovation – the Internet in the nineties, artificial intelligence (AI) today. And, as today, at the time, many regarded this hype with some caution. At the end of 1996, in a speech to the American Enterprise Institute, the then Fed Chair Alan Greenspan spoke of “irrational exuberance,” a phrase that has remained famous. The future was to prove him right, as this exuberance ended in the bursting of a bubble, provoking one of the worst falls in US stock market history.
However, there was a more than three-year gap between the pronouncement of this prophecy and the collapse of the equity market – the S&P 500 chalked up a rise of 115%, and the Nasdaq one of 465%. An investor who bought the S&P 500 on the day of Greenspan’s speech would not have lost money, even at the low point of the market in 2002[2]. This may inspire confidence, despite current fears of the emergence of a bubble around AI. Especially as – in contrast to the 1990s – many of the winners of this trend are very large, diversified and highly profitable corporates with a dominant or even quasi-monopolistic position.
That said, the current economic situation differs radically to that of the mid-1990s. The hike in rates by the Fed in 1994 – motivated solely by a move to normalisation against the backdrop of solid growth and an improving labour market – was not carried out in an environment of strong inflation. Furthermore, the cycle of tightening had been less brutal and strong growth was sustainable: on the one hand, the household savings rate was high, whereas today it is clearly below-average; on the other hand, the fiscal balance was very slightly negative and even positive between 1998 and 2000, whereas current growth is broadly subsidised by a deficit of 6% of GDP. Lastly, having peaked in mid-1992, unemployment was following a sharp downward trend – the mirror opposite of the current environment where unemployment is rising from very low levels.
Undoubtedly, investors would be well-advised to keep a closer eye on this latter issue of employment than on the risk of a bubble, as history shows that it is extremely costly to be right too early on this issue.
Final version of 15 March 2024 – Enguerrand Artaz, Fund Manager, LFDE