The Dow Jones industrial average hit a four-year high this week, but former Federal Reserve Chairman Alan Greenspan still thinks you should buy stocks.
Speaking to Bloomberg Television Tuesday, Greenspan said stocks are “very cheap.” They offer good value and are likely to rise as corporate earnings increase over time, he added.
Greenspan pointed to the equity premium -- the excess return that the stock market provides over a safer long-term government bonds -- saying it is at its highest level in 50 years. That fact, coupled with a “very low” price-to-earnings ratio, is driving investors into stock investments, he said.
“There’s no place for earnings to grow except into stock prices,” Greenspan told Bloomberg. “The point I have been making lately is we are underestimating the extent of equity stimulus in driving this economy.”
Also known as a “multiple,” the price-to-earnings ratio valuation measures the price paid for a share relative to the annual profit earned per share by a company. If it is high, investors are paying more for each unit of profit, making the stock more expensive compared to one with a lower price-to-earnings ratio.
But could Greenspan be irrationally exuberant?
Some analysts are asking if the stock market’s recent rally has run its course. After rallying neatly 30 percent since early October, the Standard & Poor’s stock index, a broad market measure, was slipped 1 percent for the month of April, as worries about the economic outlook resurfaced.
The renewed economic jitters, coupled with fears about the outlook for the euro zone, sent investors to the relative safety of bonds, meant that for the first time since the beginning of 2008, bonds were the only investments that provided positive returns for the month.
