BOOK REVIEW
Playing the markets before they play you
Market Panic: Wild Gyrations, Risks, and Opportunities in Stock Markets, by Stephen Vines

Reviewed by Gary LaMoshi

On September 17, 2001, the first day of trading on the New York Stock Exchange after the September 11 attacks, the benchmark Dow Jones Industrial Average tumbled more than 7%, among the biggest falls in market history. The attacks gave traders ample reason to sell. The United States had been hit with a series of coordinated terrorist strikes. No one knew how the attacks would affect the US economy, or whether further, deadlier attacks would follow. Investors loathe uncertainty, so they lined up to sell.

But Stephen Vines, a veteran Hong Kong journalist and entrepreneur, wondered why any sane person would sell stocks on September 17. Indeed, the terror attacks had introduced new uncertainties into equity markets and the world, but a week later it was apparent that while buildings had fallen, the edifice of Western capitalism remained solid. Among the biggest buyers on September 17 - because every share trade requires a buyer as well as a seller - were top US corporations buying back their own shares. Those captains of industry were well aware of the single absolute certainty over more than four centuries of stock-market history: unlike airplanes and buildings, when markets crash, they always rebound.

So when there's panic in the market, Vines suggests, it's time to buy, not sell. When markets are rising, investors line up to purchase stocks at high prices. But as sage investor Warren Buffett and others have observed, people wouldn't hesitate to buy a suit they liked yesterday if it went on sale at a 20% discount today. Yet they don't follow that logic when it comes to stocks.

Vines makes this point and more in Market Panic, first published in 2003 and reissued in an updated paperback version. He uses this example of irrational investing behavior as a starting point for a more fundamental analysis of stock markets from a extremely cynical and contrarian point of view. In his very readable and straightforward style, Vines ably debunks several articles of faith about stock markets as reasonable economic indicators and arbiters, enumerating the trends that make modern markets behave more like casinos than provinces of prudence. But in the end, Vines echoes Winston Churchill's view of democracy - the worst system of government, except for all the others - concluding that stock markets remain the best place for your money if you hope to build wealth.

Vines maps out strategies for building that wealth wisely, drawing on astute advice from a host of gurus, from Karl Marx to John Maynard Keynes to George Soros. Buying low, at times of panic, is one surefire method for increasing wealth. Markets, he notes, move less because of events than because of people's perceptions of events. He outlines signs that a panic - a buying opportunity - may be coming, but points out that stocks often move for odd reasons.

Wall Street's crash of October 19, 1987, a 22.6% drop in the Dow (nearly double the fall of Black Monday in 1929), lacked the signature event of other outbreaks of panic selling, such as the 1955 drop of 6.6% on news of US president Dwight Eisenhower's heart attack or the 9.9% fall two years later when the Soviet Union launched the Sputnik satellite. But the 1987 panic had its roots in fundamental, if obscure, economic factors, while those splashy news headlines of the 1950s, and even the 2001 terrorist attacks, didn't carry any real economic punch. In other words, Sputnik and Osama bin Laden didn't meaningfully impact global business prospects.

That observation leads Vines to examine the growing disconnect between business fundamentals and stock prices that came into sharpest focus during the dot-com bubble of the late 1990s. With the connivance of Wall Street bankers and brokers (effectively one and the same despite claims to the contrary), companies with few or no profits had market valuations in the billions. Companies with minuscule profits such as America Online and Hong Kong's Pacific Century Cyberworks were able to leverage their inflated valuations to purchase established companies, Time Warner and Hong Kong Telecom respectively, which had much higher profits but lower valuations (see AOL's Asian cousin, October 10, 2002). Vines attributes this phenomenon to a form of mass insanity.

Indeed, he sees mass insanity as one of the key forces driving markets. Although investing professionals hate to be accused of herding, there is no denying that fund-management professionals get caught up in trends. More explicitly, both chartists and momentum investors have simply renamed herding: they preach that stocks will rise further because they have risen already. Herding leads to panics, as the herd reverses course, and leads Vines to quote one Hong Kong trader's observation: "If you want to conduct the orchestra, you must turn your back to the crowd."

Beyond the dot-com boom and outright corporate malfeasance that came to light in its wake at Enron, WorldCom and the other companies, Vines sees the stock market as detrimental to real business success. The combination of earnings as the driver of share prices and the perverse incentive of stock options has, in his view, led to executives managing the company's stock price and accounting more carefully than the underlying business. That's a powerful but not fully persuasive argument.

The key lesson of my years in the investor-rights movement is that companies that choose to list on public markets have an obligation to maximize the share price to benefit investors; after all, shareholders, not the managers, own the company. However, Vines is right that managers (and investors) often focus too mercilessly on quarterly earnings instead of the company's long-term prospects. Committed, long-term shareholders - real investors, rather than speculators - agree with Vines' observations far more than he realizes.

Long-term investors join Vines in decrying the tendency for publicly listed companies to skimp on capital investment to boost quarterly earnings. Citing figures showing an inverse relationship between investment and share value, Vines concludes that stock markets have perverted their basic function of providing capital for growth and instead simply provide an avenue for owners and employees to extract profits from the business. Clearly, businesses shouldn't eat their seed corn, particularly when managers' goal is a stock-price pop so they can encash millions in stock options. However, the real problem isn't stock markets, but the misalignment of management incentives. The growing corporate trend away from stock options - most notably at Microsoft - is an area where Vines could have updated his observations more thoughtfully.

Overall, though, Vines intelligently analyzes what really drives stock markets today, and how smart investors can profit from bucking the trends. These days, when opening an investment account, you receive lengthy disclaimers in turgid legalese designed to limit the broker's liability, in essence by warning investors that they can lose money. Brokers and investors alike would be better served if, instead of these boilerplate documents, Market Panic became the required reading before putting hard-earned money into increasingly irrational stock markets.

Market Panic: Wild Gyrations, Risks, and Opportunities in Stock Markets, by Stephen Vines, John Wiley & Sons (Asia), 2005, Singapore. ISBN: 0-470-82152-3. Price: S$37.95 (US$19.95), 266 pages (paper).

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