The fall and rise of 20th-century investing

Ordinary people wouldn't buy stocks till the market seemed fair

During the early 20th century, the stock markets were like an Olympus where the citizens below the mount could only watch the clashes of the financial titans, writes B. Mark Smith, a former equity trader and vice president at Goldman Sachs. Speculators like Jesse Livermore and Bernard Baruch made and lost fortunes on insider information and stock manipulation, while "the paucity of publicly available information effectively precluded potential investors from making informed choices."

The stock market since then has been "evolving towards efficiency," even if there has been a "step backward" for every two steps forward, says Smith in his provocative look at the fitful evolution of the markets.

He goes to lengths to defend the efficient-markets orthodoxy, rejecting examples of "anomalies" for depending too heavily on early century data. The toughest event for efficient-markets proponents to explain away is the Crash of 1987, when no discernible event could be found to justify the 30 percent drop on October 19, 1987. Yet Smith continually contends that higher stock prices are a trend toward "more aggressive standards" of valuing stocks. Such aggressive standards during the 1990s were sufficient to make Alan Greenspan the first Fed Chairman since the 1960s to remark on excessive stock market levels when he warned of "irrational exuberance."

"The Federal Reserve should let investors set stock values. It is not the function of the central bank to do it for them," Smith counters, adding that Greenspan has changed his tune since the infamous speech. Stocks were not necessarily overvalued even before the notable crashes of 1929 and 1962, "given that investors who bought stocks at those 'high' prices still earned good returns going forward."

However, that argument assumes that investors were broadly invested and hung on for the long term. Smith admits that during the crash of 1929, the overvaluation was concentrated in approximately 20 percent of stocks. More startling is the just-released Bianco Research study that shows 20 stocks were responsible for more than 76 percent of the losses since last year's peak in the NASDAQ.

Still, perhaps the millions of shares now traded daily confirm Charles Merrill's "belief that there was a vast pool of interest in the stock market that could be tapped if the public could be assured that the market was fair and open." Reforms to improve the flow of information and the establishment of the Federal Reserve as lender of last resort have helped in this "market democratization."

Smith's book might rouse some to new interest in the theories behind investing, but where he truly succeeds is in the way he pulls together and contrasts accounts of financial titans like J.P. Morgan, speculators like Livermore and Baruch, and academics like William Sharpe and Eugene Fama.

Wayne E. Yang works for a Connecticut-based buyout firm. His writing has appeared in The North American Review and aMagazine.

(c) Copyright 2001. The Christian Science Monitor

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