Former Federal Reserve Chairman Alan Greenspan went from enjoying fawning adulation and a reputation as “the best central banker to ever live” to being named one of the 25 people most responsible for the financial crisis.
Take his advice as you wish.
Here, though, is what Greenspan told Bloomberg about U.S. stocks yesterday:
Well, stocks are very cheap. All you have to do is look at the equity premium. The best estimate of the equity premium, as best as I can judge, is JPMorgan’s. And that’s at the highest level in 50 years. And that essentially means that, with earnings still moving up — as they have until very recently — when you run up against a very high equity premium … there is no place for earnings to grow except into stock prices.
And the point that I’ve been making recently is that I think we are underestimating the extent of equity stimulus, as distinct from fiscal stimulus, in driving this economy. …
We don’t recognize how important the equity markets are in a market economy. We lost, globally during the crash, $35 trillion in listed corporation value. And equity is the collateral of the financial system. It’s not only the equity amounts, but it’s also the fact that where equity prices are essentially tells the bondholder how much buffer there is between what he holds and bankruptcy. The bigger the market value increase in equity, the greater the quality, other things equal, of what bonds are.
You can see the rest of the video here.
The “equity premium” he speaks of is the excess returns stocks provide over risk-free assets like Government bonds. That premium is huge in the US right now because interest rates are at historic lows. Even with the dividend payout ratio near an all-time low, the S&P 500 (INDEX: ^GSPC) yields more than 10-year Treasury bonds. That almost never happens. And when it does, it’s typically a good sign for stocks — especially relative to bonds or cash.
There are plenty of counterarguments here, namely that just because stocks look cheap relative to bonds doesn’t mean they’ll offer good returns. US Government bonds are almost certainly offering negative returns once inflation is factored in. Stocks may produce more than that, but it might not be anything to write home about.
Some stocks look much better than others, of course. A couple that still look good to me include large caps such as QBE Insurance Group (ASX: QBE) — trading at a low price-to-book value — and Telstra (ASX: TLS), which still has an very attractive grossed up yield of 11.1%. Small caps crushed large-cap stocks over the last decade. There’s a good chance it will be the other way around over the coming decade.
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A version of this article, written by Rick Munarriz, originally appeared on fool.com