GREENSPAN: A 'Significant' Market Correction Has To Come

A week ago Wednesday, the S&P500 hit another new all-time high, continuing an incredible five-and-a-half-year run of average gains.

For former Fed chief Alan Greenspan, the surge will have to end at some point. Appearing on Bloomberg's "In The Loop with Betty Liu," Greenspan warned :

...the stock market has recovered so sharply for so long you have to assume somewhere along the line we're going to get a significant correction. Where that is I do not know, but I would not say that we are grossly overpriced at this point in a historical context.

Greenspan pointed to the fact that the equity risk premium (ERP), which measures the rate of return on stocks versus returns on bonds, remains below the levels we saw in the run-up to Lehman. NYU's Aswath Damodaran is known as the risk premium guru, and he has shown that with a risk premium of 5%, stocks aren't significantly overvalued, though that level is above the historical median.

"It's now come back to what I would see as closer to normal after being exceptionally high. And that means that, no, we are not yet in a stressful position," Greenspan told Liu.

Here's Damodaran's chart, with the equity risk premium in green and Treasuries in red:

Aswath Damodaran/NYU

One problem is that there is no precedent for current Fed policy, Greenspan said.

"...None of the central banks have ever been anywhere near where we find we all are and where we have to move as a consequence of the crisis," he said. "But what we do not know, and we can guess, but it is a guess and I shouldn't - we shouldn't parade it as some great intellectual insight. We just do not know how this thing is going to work out when we begin to tighten."

The S&P was down 0.1% Wednesday.