Greenspan's probability factor cut

LUCKILY I've encountered some extraordinary people at various times in my life. As a student, I came across Mike Stanley. Anybody who studied geography at High School Yards at Edinburgh University in the 1960s or early 1970s will have bumped into him. He was a great thinker and eccentric.

But it was on field trips he displayed his hidden talent. He told long wonderfully clever jokes. One stays in my mind after all these years and illustrated the difference between probable and possible. While it's impossible to tell this joke in a family newspaper, the punch line involved "probable" as being something 90 per cent likely to happen and 10 per cent unlikely to happen. "Possible" was described as being 10 per cent likely to happen and 90 per cent unlikely to happen.

Which brings me to Alan Greenspan the retired US Federal Reserve chairman, who still earns a few bob making speeches. Apparently he's promoting his memoirs about to be published which perhaps explains why he's come to the fore in the last couple of weeks.

Before the end of February, as you may have noticed, world stockmarkets fell sharply. It all seemed to start in China and it was widely reported the Chinese economy was stuttering, their economic miracle over, so share prices were too high.

It's not often reported there's a different equity market for Chinese nationals from foreign investors. The Chinese government became concerned about the over exuberance of Chinese nationals who were buying shares with credit cards. So the authorities hinted they were thinking of introducing a 20 per cent capital gains tax - and investor panic ensued.

Simultaneously, on the other side of the globe, Greenspan suggested a world recession was probable. Before long, he changed his mind to "possible", even apparently by the end of this year. Odd that, when evidence supports positive conclusions. But that doesn't sell books, does it?

Harry Dent, the enthusiastic demographic economist - you don't often see enthusiastic and economist in the same sentence - referred to Greenspan as the great pessimist. Actually Greenspan's not alone. Paul Krugman, another eminent US economist who wouldn't be able to spell the word optimist, has just released his ninth prediction of a recession since 2003. Do these people never get embarrassed?

I MAY have mentioned this before - recessions are a bit like baking the perfect Black Forest Gateau. If like me you are a useless baker, you have to use a recipe. Each recipe, as you are probably aware, carries a list of ingredients. Some ingredients are more important than others.

It's the same for recessions. I don't think there would be too much of an argument if I said the main ingredient in the recipe for a recession is lack of liquidity. That's a fancy word for cash drying up, or tightening credit facilities. And right now, everywhere you look, we've got liquidity coming out of our ears.

So let's look at the other recipe ingredients we've got now. Some 1.5 billion new consumers in the capitalist system, highly positive demographics, low interest rates and inflation, positive economic cycle, corporate earnings growth still in double digits, especially in the US, low unemployment, at least a 5-1 ratio of assets versus debt, and investor sentiment flashing extreme pessimism.

The crowd sentiment indicator, which measures extremes in pessimism and optimism, as I have reported before, is the most accurate short-term indicator. Over the past 20 years, if you bought equities when it triggered extreme pessimism, and sold them when it triggered extreme optimism you would be reading this column online on your private yacht somewhere in the Caribbean.

In the past ten years, out of the 61 times extremes were triggered in this sentiment indicator, the crowd were wrong every time. The level of pessimism today is actually higher than it was prior to the Iraq war in March 2003. And if you can think of a better time to have bought equities in the past seven years, I can't. So it's probable this is a great buying opportunity, and it's possible pessimists will get it right one day.

WHAT excuse will they dream up next? Last week it was announced a 4 per cent drop in Guinness sales is down to global warming. Demographic research predicts that, as a population ages, beer sales fall and wine sales rise. I wonder if that explains the increase in the sales of pink wine? It certainly cuts down the trips to the loo.

• Alan Steel is chairman of Alan Steel Asset Management. www.alansteel.com