Why 2006 Is Different Than 1995

by: Barry Ritholtz

The 1995 soft landing meme gets a thorough going over in Greg Ip's column today: Why Fed Might Keep Rates on Hold Longer Today Than It Did in 1995, from a monetary policy perspective:

"Investors looking for a road map to the Federal Reserve's next moves on interest rates often look to 1995.

At the time, the Fed had raised interest rates steadily after a long period of unusually low rates. With the U.S. economy slowing, it paused for five months and then started cutting rates.

Many investors have been looking for that cycle to repeat itself and expect the Fed, which last raised interest rates in June, to begin cutting rates at some point in the next few months.

This year differs from 1995 in ways that suggest the Fed could stay on hold longer. One is that interest rates are lower now than back then. Another is that Fed officials' tolerance for inflation is quite different today."

Whenever I see a comparison between now and 1995, I am compelled to mention the following differentiating factors:

1) We were in the middle of an 18 year Bull market (versus being 5 years out from a horrendous tech crash, with the Nasdaq down 78%)

2) Post 1987 crash, the Fed cut rates, and real estate responded.By 1994/95, that cycle was long over.

3) Housing was only a minor sector of that economic cycle, versus the 2002-2006 version. As RE, and numerous rust belt industries were fading, there were plenty of other sectors to take its place:

-Wireless buildout;
-Internet ramp up;
-PC upgrade cycle
-SemiConductors and CPUs (286/386/486/586)
-Windows 95

These are all more mature industries today.

4) No other sectors in today's economy are parallel to the short list above to take over for Residential Real Estate. Candidates include: Stem cell research, alternative energy, nanotechnology; even Commercial R/E is a third the size of Residential.

Lastly, consider the monetary conditions now versus then:

"A recession and weak expansion in the early 1990s helped nudge inflation lower, and "pre-emptive" rate increases in 1994-95 kept it from rising again. Accelerating productivity growth in the late 1990s, which enabled the economy to grow rapidly with less strain on existing capital and labor, nudged inflation lower still. Mr. Greenspan later declared that price stability had been achieved by mid-2003, when core inflation was between 1% and 1.5%. Core inflation has since risen to 2.9%, according to last week's report on September's consumer-price index; it's a bit lower using the Fed's preferred-price index. Though the Fed has no official target for inflation, Mr. Bernanke and many of his colleagues have often suggested a ceiling of about 2%, and all agree today's rate is too high."

The exercise gives the entire soft landing thesis a splash of cold water . . .