Sunday, June 21, 2009

Book Review - Market Panic

I just finished reading the book “ Market Panic” by Stephen Vines. I would say more like browsed through it. The book is ok read slightly repetitive but did have a few good things.

I liked the author’s structure on the various stages of a stockmarket cycle leading to the final panic exit that most markets demonstrate at the end of the cycle.

Listing down how the author has described the various stages of the cycle

Stage I
The cycle starts with some kind of external shock the system that creates important opportunities for atleast one sector of the economy. It could be a event like a war or new inventions like the railways or more recently the rise of the internet

Stage 2
This boom then gets enlarged largely fuelled by expansion of bank credit expanding money supply ( Greenspan being a case in point).

Stage 3
With greater liquidity in the system euphoria takes over and as “Adam Smith” put overtrading. This results in greater trading volumes and higher level of speculation and leverage that builds into the system

Stage 4
As the author quotes “There is nothing so disturbing to one’s well being and judgement to see a friend get rich”. So everyone one wants to get rich. People who haven’t thought of entering the stockmarkets suddenly start investing in the markets.

Stage 5
The real danger signals starts when the stockmarket news moves from the inner pages of non financial newspapers to the front pages. I quote the author “Illustrating this point was the alarming appearance of mutual funds as a “Playboy” cover story. When stocks replace scantily clad young ladies who are well endowed on the cover, logic has clearly taken a holiday’.

Stage 6
Not only does the stockmarkets get inundated with inexperienced participants but their very presence increases demand leading to the temptation and opportunity for many new equity issues designed to capitalise on the window of opportunity for selling all manner of assets at an inflated price. This also leads creation of new derivative products allegedly aimed at sophisticated investors increasing leverage in the system and building pressure. This starts process where lenders start calling in additional margin with central bankers stepping in to deflate the bubble.

Stage 7
As the bubble grows the markets starts losing all sense of connect with the underlying assets.

Stage 8
At this stage a number of scams and dubious investments start coming out. This is interesting as a symptom if not the cause of stockmarket panics.

Stage 9
At this stage the savvy investors sense the top and start exiting from the market. Newer players are unsure and tend to stay put resulting in brakes on the rapid upward price movement. As the “greater fool” becomes difficult to find there is increasing movement from assets into cash resulting in depressing prices leading to unwinding of leveraged positions.

Stage 10
Now the market is in full retreat and there is competition to get out or the rush thru the door. This is typically led/ followed by the dramatic failure of a bank or other institutions or a particular scam.

Stage 11
This is final stage where the very assets which were darlings of the market become the object of revulsion and there is a market wide panic that builds up invariably leading to the regulator putting on cap in terms of limits or acting as a lender of last resort to bring stability and confidence to the markets

I have personally seen about three cycles and I can say that this is a fair template of how the markets move. Of course to add to it I always hear the magical four words “ This time its different” :-).

2 comments:

REVerenD said...

true indeed... However there is something about the way things go from stage 11 to stage 1 dont you think?

Uhm been reading The Ascent of Money by Niall Fergusson. It traces the history of money from mesopotomian and astec times to as we know it today.

Oh and one more thing, if i May ask.. your views on Mphasis as a potential delisting candidate? An article I came across suggests that HP has no listed subsidiaries in the 170 countries it operates and makes a case for delisting. They have cited Digital (a subsidiary of Compaq) which they delisted. Happened in 2001 or so.. Your insights please?

tc

Ninad Kunder said...

Hi Reverend

Yeah they for sure move from Stage 11 to Stage 1 always with new money getting sucked in. The amazing part is how the cycle keeps repeating itself.

Will try to lay my hands on the book that u recommended. It would interest me as it goes with my interest in history . If u like to read history and how it evolved would strongly recommend
" Guns Germs and Steel" by Jared Diamond".

On your Mphasis question, I understand your thought process and I have a few similar companies on my radar. Let me come back with my answer with another post on how I evaluate it.

Cheers

Ninad