by Michael J. Panzner
(Prentice Hall, Upper Saddle River, New Jersey, 291 pages) $24.95
Traders, especially institutional traders, have much to worry about these days.
This book suggests that they should be asking more and more questions about uncertain markets. They should also consider the effect of elections on the economy.
How stable and predictable are markets? Are they, as the advocates of the Efficient Market Theory (EMT) insist, always correctly priced? And how effective are central banks in regulating markets as well as smoothing out their persistent volatility?
Michael Panzner, a former trader and salesman over two decades for firms such as J.P. Morgan Chase, Soros Funds, Dresdner Bank and ABN Amro, uses this book to poise these hard questions. Clearly, he is skeptical that the regulators can reduce the trading bumps. And he is fearful that trading and investing will become much more difficult than in the 1990s when almost everyone seemed to win. But the markets of the 1990s are now just a dear memory.
Panzner argues in these pages that volatility has become so in bred in markets that they have become jungles. Indexes are, at times, distorted by the increasing incidence of volatility.
The author of this impressive, compelling work also contends that institutional traders are vulnerable to these new higher levels of volatility. Therefore, the book contains analysis of various market and economic problems along with a series of proposed strategies for coping with them. Panzner calls these survival techniques actions plans. He notes that buysiders, aware of the new realties of the stock market jungle caused by unprecedented volatility, are taking defensive steps. For example, when there is a sharp move in a market, Panzner says, sage buysiders are paying attention to what happens after the initial swing in an index or a stock price share.
"In some respects," he writes, "the follow-up action appears to reveal a measure of hidden supply or demand that has been poised to react when a fleeting opportunity presents itself. Although it is more art than science, one general rule of thumb worth keeping in mind is if the recovery bounce that occurs within the first hour of a catalyst-driven slide fails to recapture at least two-thirds of the initial move during that time, then there is a reasonable chance that at least a short term retest of the initial lows – or worse – will soon unfold." (page 223).
The author, who is now vice president of an international financial services firm, also calls into question the ability of central banks to prevent bubbles and crashes. Our own central bank, he suggests, doesn't command the respect it once did.
For example, one of the leading American investors, Warren Buffett, no longer puts all his faith in the almighty dollar as America's economy starts to slow down because business is going abroad.
"Berkshire Hathaway," Panzner writes of Buffett's investment vehicle, recently began "buying foreign currencies for the first time ever, on concerns about the United States' deteriorating trade balance. Consequently, this raises the prospect that an even modest retreat could turn into a full-fledged rout if domestic investors really start to join in." (page 254).
However, those who believe in the inherent rationality of the stock market – that prices always correctly reflect the underlying values of the economy and of stocks – have argued that there is nothing to worry about; that the market will always correct imbalances through the efficient market theory. Again, Panzner is a skeptic.
"In the hypothetical world of EMT," Panzner warns, "anomalies such as stock market bubbles cannot really exist – or if they do, they are but one of what appears to be a series of exceptions to the rule. However, like those who believed in the emperor's new clothes, it seems that many former adherents are starting to come around to the idea that the reality of investing is somewhat different than what they originally thought." (page 259).
This is a good book that financial professionals should consider as a kind of course in trading jujitsu. The author provides various strategies that he hopes will help professionals cope with a dangerous trading world. I say that because we are less than two years removed from a bear market and there is a possibility, if history repeats, that the bear soon will be roaring again.
Indeed, the author also suggests that pols often pump up the economy and the markets around election time, knowing that the pain will come in the first year of a new term. That's when the average pol is least vulnerable and has the most time to turn things around before the next election. Also, Panzner currently notes that governments, which often clamp down on financial professionals who tried to pump up markets, aren't above using their own shady practices.
"Ironically, while manipulative practices are generally frowned upon in traditional investment circles, governments around the globe have relied on such measures for centuries to stabilize economies and markets," Panzner writes. "From overt cheerleading to covert buying and selling of securities using taxpayer funds, politicians and central bankers regularly attempt to influence prices in the name of public policy."
"Similarly," Panzner continues, "they often act to smooth the bumps of normal cyclical activity or, on occasion, to achieve outcomes driven by less than honorable ends." (page 39).
Politicians and central bankers, the author writes, will often do some interesting things when elections are anon. "One such example," Panzner explains, "is the Presidential Election Cycle, which describes a tendency for the stock market to strengthen in the third year of a four-year term. Generally speaking, the move takes place in response to stimulative measures fostered by the incumbent administration in a bid to boost re-election prospects the following November." (page 161).
This kind of wizardry definitely happened in the 1971-1972 election cycle. The consequences of this fiscal and monetary legerdemain were felt in the rest of the 1970s.
The consequences were called stagflation.
Looking to 2005, one rises from this book thinking: Is history about to repeat itself? Panzer makes no predictions but certainly he is pessimistic, maybe even fearful. Again, he has a warning about those who think that the central bankers can manage this or that we can ever avoid the pressures leading markets to revert to the mean: Re-examine your premises. He says there is "an increased risk of a major financial accident taking place over the next few years – one which may ultimately affect all investors, large and small." (page 261).
Traders would be well advised to consider some of his proposed remedies for unsteady markets and the broken dreams of central bankers.
