"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?"
This once sentence, implying that asset values had reached a level of irrational exuberance, sent the financial markets into a tailspin around the world. Japanese shares immediately fell 3%. The U.S. markets woke up the next morning to find futures sharply lower. With a simple sentence, Greenspan literally rocked the world.
Fast forward to this week and current Federal Reserve Chair Janet Yellen provided the following quote to the media:
“We've also seen a compression in spreads on high-yield debt, which certainly looks like a reach-for-yield type of behavior. I would highlight that equity market valuations at this point generally are quite high. Now, they’re not so high when you compare the returns on equities to the returns on safe assets like bonds, which are also very low, but there are potential dangers there.”
What followed Yellens very direct comments that equity valuations are "quite high" with "potential dangers?"
The markets did not even notice. Everyone is 100% confident the Federal Reserve will continue to artificially move asset prices higher that comments coming directly from the Fed on the danger within the markets are casually brushed away.
If we were in a period of "Irrational Exuberance" entering 1997 we have certainly entered a period of "Maximum Insanity" as we move through 2015. The more complacent/euphoric market participants become the greater the sands of instability rise under their feet. When they finally shift, it will feel like an earthquake.