Remember Alan Greenspan’s tag line about “irrational exuberance?” He uttered it at a Fed board meeting back in the early days of the tech bubble.

This hardly made him popular with those bright lads and ladies in Silicon Valley and Gucci Gulch who were desperately propagating the fraud that was to become known as “the Great Tech Bubble.”

And in the end, Alan apparently decided to choose popularity over practicality, because just when he should have stuck to his guns – when he would have been proven magnificently prescient – he caved and became the bubble’s biggest cheerleader.

Rational Values…

Now we hear a strange sort of inversion coming out of the dark corners of Wall Street. We are told that we have become “irrationally despondent,” and have sold U.S. stocks below their true values.

The argument they are trotting out goes somewhat like this: “The S&P’s traditional benchmark P/E is 15 (or maybe 16, unless it is 14; they aren’t quite sure). And right now it is somewhere around 13” (or maybe 14, again, they can’t quite nail this down from one hour to the next). “So you should buy stocks now! (please?)”

It seems like such an intuitive way to measure what something ought to be worth. Figure out what profits were when stocks were at thus and such a price. If that figure is low now, well, they ought to go up, right?

…Or the Path to Disaster?

Unfortunately, it just doesn’t work that way. In fact, the S&P 500’s historical P/E has proven to be a lousy predictor of future movement. For example, in late 2002 it reached a whopping 45 and change: a clear sell signal!

Except that the Fed was about to pump a boatload of cash into the system, so as to inflate the real estate bubble. In 2007, when we were witnessing the very last glory days of that bubble, P/Es were generating a buy signal at 15.

Clearly, the market is far too irrational for this sort of math.

What’s Spooking the Herd This Week

Here are some of the signals investors are seeing right now that for some reason overwhelms that cool reasoned argument:

• New home construction just fell to its lowest level since 1991. The building industry is on pace to construct the fewest new homes and apartments since the end of WWII.
• Consumer sentiment just suffered its biggest one-month drop EVER, and has just beaten the index’s record low set in 1980.
• Unemployment has been running above its recessionary marker for 13 straight weeks. There are now some 9.5 million Americans looking for work and another 1.6 million who have given up looking.
• Manufacturing is collapsing: The bellwether Philadelphia Fed survey just took its steepest one-month plunge ever, diving from a wan-but-positive 3.8 in September to a disastrous negative 37.5 in October.

A Rational Path Forward

So what would it take to turn this stampede? The old tired arguments are clearly done for. What investors need now is not platitudes about their foolish selling from cheerleaders trying to talk up their book.

Rather, they need to hear something new, something concrete, something different. They need to know that we are still the country of innovation, a place where guys in their garages can invent something that might completely turn the tide.

In Friday’s Taipan Daily, Justice put forth that this might come from breakthroughs in green technology. Lord knows we need more here, as we are clearly choking on our own refuse.

Our overseas reporter, Sara Nunnally, has suggested that perhaps genuine value can still be found in the back corners of Eastern Europe, where for years, they were denied the “opportunity” to over-inflate values in the first place.

There is clearly a major shift happening here as the real economy of the 21st Century slowly reveals itself, and the last remnants of the old, the chaff, the deadbeats and liars get swept away by the tide.

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