Bank stocks tumbled dramatically on Wednesday after Federal Reserve Chairman Alan Greenspan warned that inflation could soon re-ignite and cause interest rates to rise.
"Job growth slowed significantly in August and September, but it did not slow enough," Mr. Greenspan told the House Budget Committee. "Thus the performance of the labor markets this year suggests the economy has been on an unsustainable track."
His morning comments helped send financial markets into a tailspin with only moderate recovery later. Financial stocks were particularly hurt as nervous traders quickly translated Mr. Greenspan's words to mean higher interest rates soon.
The Fed chairman's remarks recalled his now famous reference last December to "irrational exuberance" in stock prices. Stocks plummeted afterward, but soon recovered while Mr. Greenspan endured some congressional criticism.
On Wednesday, Mr. Greenspan was less explicit but said it "clearly would be unrealistic" to look for a continuation of stock market gains anything like the magnitude of those recorded during the past few years.
In Wednesday trading, the Standard & Poor's bank index fell tk%, while the Dow Jones industrial average declined tk%. The Nasdaq bank index tumbled tk%, and the S&P 500 slipped tk%.
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While the stock plunge was vivid, most market experts dismissed the downdraft for banks as simply an overreaction. In fact many analysts were trumpeting the slide as an opportunity to buy.
"The market continues to overreact to the interest rate sensitivity rule, and I would take advantage of that," said bank analyst Robert B. Albertson of Goldman Sachs & Co. "There is no fundamental reason for interest rate increases to have anything to do with bank earnings growth."
Bank earnings clearly will be in the double digits this quarter, Mr. Albertson added. And he pointed out that the market's overreaction to the possibility of higher interest rates appears to be on the decline.
"Banks have neutralized their interest rate sensitivity to virtually negligible numbers," said Mr. Albertson. "Investors eventually will tire of chasing the old concept about rates."
Chief economist Thomas Carpenter at ASB Capital Management in Washington also scoffed at the markets' reaction to Greenspan's comments.
"I still can't figure out what the market is getting excited about" said Mr. Carpenter, who spent the morning poring over Mr. Greenspan's speech. "Anybody who knows about the capital markets knows that 20% to 30% rate of return is not sustainable. All Greenspan did was repeat the obvious.
"We will get to zero inflation and at that point the equity increases in the price earnings level will be over."
In spite of this, bank stocks will continue to do well because of consolidation and new product opportunities, he said.
Other analysts, however, are not so bullish and see the slippage in bank stocks as a sign of gloomier times.
"It is clear there is a significant deterioration beginning to show up as they relate to bank earnings," said veteran bank analyst Richard X. Bove of Raymond James & Co., St. Petersburg, Fla.
"You are getting Greenspan speaking today indicating that the economy cannot sustain the growth .... yet the stocks are up 1% a day in price," he said. "This is a mania, and it doesn't make sense that these stocks continue to surge in price when the fundamentals are clearly rolling over."