Stock Pollyanna

TOWARD RATIONAL EXUBERANCE

The Evolution of the Modern Stock Market

By B. Mark Smith

Farrar, Strauss & Giroux -- 342pp -- $25

After the pounding that portfolios have taken in the past 14 months, many investors will welcome a stock market history reassuringly titled Toward Rational Exuberance. Indeed, its buoyant outlook will make the volume pleasant reading for those seeking an introductory digest to 20th century financial events. Author B. Mark Smith argues that the haunting crashes and plunges of 1929, 1962, 1973, and 1987 were the result not of irrational speculation destined to be repeated but were merely bumps in the 20th century evolution of the market toward successively higher peaks in stock valuation. Investors and traders who through the decades pushed up prices weren't all just gambling. Many foresaw future economic growth and appreciated changes that have made the markets more fair and orderly.

Who would take such a charitable view of market volatility right now? One of Wall Street's own, not surprisingly. Smith is described on the book jacket as "a retired stock trader with nearly two decades of practical experience" at Credit Suisse First Boston and Goldman, Sachs & Co.

Employing previously published histories and news articles as his sources, Smith tries to debunk warnings of speculative bubbles. He alludes to studies showing that stock valuations have eventually returned to their pre-plunge peaks. For example, he argues that the market's overall price-earnings ratio before the 1929 crash wasn't outrageous because it was only 16.3--half as much as recent levels. And, he notes that while the Nifty 50 stocks of the 1972 bull market collapsed in 1973-74, they delivered solid returns if held for 25 years. The problem with that argument, of course, is that it glosses over the pain investors feel when stocks plunge. And just how many investors are going to hold on to a stock for such a long time? The market fell 89% from its 1929 peak to its 1932 low and nearly 60% from early 1973 to 1974. Many people can't wait decades for another big bull market before cashing in their stocks. Smith pays scant attention to the peak in stock prices in 2000, saying only that there has been "no real evidence" of bubbles in large-capitalization stocks (he grants that bubbles may have existed in small stocks, such as Internet issues).

When he turns to changes in market regulation and oversight, Smith makes a stronger case for increased public confidence. There are engaging descriptions of early-20th-century stock manipulations that could not be repeated today. He tells how, in 1907, a panic was averted only because of the actions of J. Pierpont Morgan, playing the role now enjoyed by the Federal Reserve System governors. But little of this is fresh. Toward Rational Exuberance may be best left to those in strong need of a restorative tonic.

By David Henry

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