BOOKS: If you can keep your head ... Market Panic; By Stephen Vines; Profile pounds 19.99

BOOKS: If you can keep your head ... Market Panic; By Stephen Vines; Profile pounds 19.99 - To buy stock when others are selling may not be an original tip, but this study sets out to explain why the tactic works. DeAnne Julius appreciates its clarity.

by DEANNE JULIIUS, a director of Lloyds TSB, BP, Serco and Roche
Last Updated: 31 Aug 2010

To buy stock when others are selling may not be an original tip, but this study sets out to explain why the tactic works. DeAnne Julius appreciates its clarity.

Are you nervously awaiting the right moment to put your savings back into the stock market? This book will provide you with the rationale to do it now. Vines believes that panics - times of substantial falls in broad market indices - are the best times to buy shares. Using data going back to the 1920s, he demonstrates that buying during a falling market is often the best strategy. While you may not be able to pick the bottom of the market, by going in when prices are falling you are likely to be there for the biggest gains.

While the theory in Market Panic is based on the obvious advice to buy low and sell high, Vines grounds it in a persuasive critique of the efficient market hypothesis. If markets were efficient, share prices would faithfully reflect the discounted future value of corporate earnings. Prices might jump suddenly if new information changed expectations of earnings, but the market as a whole would follow an unpredictable 'random walk' in the short run. Vines shows instead that powerful market momentum and positive feedback cycles can develop. These are difficult to reconcile with the efficient market hypothesis.

To Vines, markets are schizophrenic. They often behave irrationally in the short run by over-reacting to new, but trivial, information and to events that have little economic impact. Eventually, however, rationality reasserts itself and trends snap. This schizophrenic behaviour allows profits to be made by those with the courage to buy when others are selling.

So far, so good. If you can foresee the fundamentals of the macroeconomy or of a com-pany better than those who are swayed by the latest blip in the unemployment rate or rumour of an asbestos claim, then you can beat the market by buying on the dips. But just occasionally the latest rumour turns out to be a warning of a real storm. How would Vines' buying strategy have fared during the past three years of broadly falling markets?

The most entertaining parts of this book chronicle the corporate scandals and extravaganzas of the past five years. It has been an incredible period and Vines' clear journalistic prose enables the reader to gallop through it. Interviews with an experienced trader and fund manager add colour and depth. Vines has done his homework and draws interesting parallels between recent events and the analyses of panics past by Kindleberger and Galbraith. This convincingly demonstrates that the 1996-99 period was a classic stock market bubble. After the bubble comes the panic - the best buying opportunity for the savvy investor.

But Vines gets into difficulty when he goes beyond this simple message into larger, more controversial issues. He questions the effectiveness of stock markets in raising capital for companies. He worries about the danger of increasing 'control' over markets by institutional investors.

He argues against diversified investment portfolios. These are all important issues that deserve careful analysis. Vines takes the contrarian position on each of them but fails, at least in my view, to carry the arguments.

For example, on diversification, Vines quotes studies showing that equities have outperformed bonds over various historical periods, and that US equities have outperformed other equity markets. Furthermore, one very long term study has found that the volatility of stocks has been lower than that of government bonds. On this basis, Vines concludes that a 100% US equity portfolio is the best bet. He does not go into the statistical problems with the studies, such as survivors' bias, nor does he qualify his recommendations according to individuals' varying risk or time preferences. A 59-year-old investor approaching the day when his portfolio will be exchanged for a retirement annuity could be misled by Vines' advice. One hopes that readers who buy this book are streetwise enough to view some of its conclusions with a degree of scepticism.

Market Panic should sell well. Its message is an upbeat one at a time of excessive gloom in the markets. The style and level of analysis are well suited to the armchair investor. The explanations of how booms and panics develop are sound and at the same time entertaining. But it is best to ignore the polemics.

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