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Toward Rational Exuberance: The Evolution of the Modern Stock Market
By B. Mark Smith
Farrar, Straus and Giroux
342 pgs. US$25/C$39.95

How things change yet stay the same

By Steven Martinovich
web posted June 4, 2001

Toward Rational Exuberance: The Evolution of the Modern Stock MarketLike most failed investors I have too many books which promised they could help me turn my one penny into two pennies by playing in the stock market. As I used each book in turn I faithfully followed the strategies laid down only to turn two pennies into one. It turns out there may be a good reason why those books always failed me.

According to B. Mark Smith's Toward Rational Exuberance, the market is an ever-changing creature that routinely shrugs off old rules in favor of new ones. If you want to understand how the modern stock market works you have to understand that it is the product of an evolutionary process, and no market can be compared to one in the past and conversely, trends can't be extrapolated into the future. If that doesn't discourage you, Smith also believes that investors have to learn how the evolutionary process works before they can begin to understand how the stock market functions.

Toward Rational Exuberance isn't a mundane guide to picking stocks but rather it is a study of the modern stock market beginning in 1901, a time that Smith says major trends began to manifest themselves that would define what today's market has become. The turn of the previous century saw a New York Stock Exchange laughably primitive to today's but incredibly different from its beginnings in the 1790s when it served as a base for trading primarily in bonds.

Though the bloom has come off the today's stock market thanks to the dot com implosion, the market in 1901 was viewed with widespread suspicion. A lack of transparency and information and a belief by brokers that they should be allowed to operate free from the restraints of public and government opinion combined to give the institution the odor of a swamp and make it the province of the very rich. From there Smith weaves his way through a century of characters ranging from infamous early stock speculators to god of the moment Alan Greenspan. Along the way, a constant idea threads its way through his narrative. The stock market is becoming less risky to invest in and thanks to competition is becoming ever more efficient.

What the end result of these trends will be is a matter for debate. According to Smith, two schools of thought today dominate the study of the stock market: believers in the efficiency of the market -- a stock price reflects the sum total of knowledge about that particular company -- and behavoralists -- those who believe that investors are affected by the noise of rumor and uninformed guesses which causes volatile markets. Smith doesn't endorse either idea, a wise move considering all the methods of analysis that have been left along the side of the road over the past century.

Smith could have decided to concentrate on a narrow range of years to make his point but thankfully each decade rates a good luck. Not surprisingly though, the book seems to give the stock market crash of 1929 and the Great Depression the deepest and most colorful coverage. Although the argument that the depression wasn't caused by the market crash - stocks had been trending down for months before the collapse in October - is hardly new, Smith raises several points that are usually ignored to strengthen his case, points raised - rightly or wrongly - by experts today explaining the Internet implosion.

If Toward Rational Exuberance has a weakness is that Smith only gives a cursory glance at the effects of politics on the stock market. While he does chronicle specific incidents of intervention in the economy by presidents such as Franklin Delano Roosevelt and John F. Kennedy, how day-to-day political influences distort the functioning of the market is largely ignored.

Despite that flaw, and it is an important one, Smith's work is an impressive entry in the field if only because of its accessibility. Proving that writing about the dismal science doesn't have to be dismal, Toward Rational Exuberance is an enjoyable way to learn the history of the ongoing drama of the market and why the investing tips your parents gave you probably didn't work when they were using them, much less when you employed them.

Steven Martinovich is a freelance writer in Sudbury, Ontario.

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  • Is Greenspan following in the steps of '27? by Gerard Jackson (December 11, 2000)
    It's said that Alan Greenspan is a student of the economic mistakes made in the 1920s ahead of the Great Depression. If that's so, asks Gerard Jackson, why is he making the same mistakes?
  • Revisiting the stock market crash of 1929 by Charles A. Morse(April 24, 2000)
    Charles A. Morse opines that the crash of 1929 was caused by the Federal Reserve and not capitalism run amok

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