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Economics meets investing

Cocktail economics, an approach devised in a bid to interest a bored batch of b-school students, aspires to reduce complex economic theories to common sense basics that can be applied to smart investing, writes Sushmita Choudhury.

Sushmita Choudhury        Print Edition: January 22, 2009

Cocktail Economics

Why are bonds akin to wood? What can moonshine, mountain climbers, power plants, salmon and football players teach one about investing? It's questions like these that make economics an excellent conversation piece and the starting point for gleaning investment truths, promises Victor A. Canto.

Cocktail economics, an approach devised in a bid to interest a bored batch of b-school students, aspires to reduce complex economic theories to common sense basics that can be applied to smart investing. This book about the marriage of economics and investing will help you construct a winning asset allocation plan.

Canto makes a strong case for avoiding beta as the sole determining factor. The risk inherent in a stock or asset class in relation to the overall market is known as beta. By and large, in a rising market, a beta of over one is likely to outperform the market. But sometimes, as Canto illustrates through the US airline stocks, despite high betas and a bull run, you can underperform.

Cocktail Economics
Price: Rs 1,077 | Pages: 300
Author: Victor A. Canto
Publisher: FT Press

Airline stocks gained only 37% during 1983-1992, well below the industry average of 181%. The only way to use beta as a profit-generating tool is to combine it with the concept of elasticity. An industry is inelastic when it cannot easily shift modes of production to meet supply. The airline industry, with its government-controlled fares and routes, was very inelastic. The key is to own inelastic, high-beta stocks during bull markets and dump them in bad times.

But how do you catch elasticity at the right time? The first step is to watch out for economic shocks, be it a tax cut or inflation shift. Then observe how sectors respond to the shock: inelastic industries respond to positive shocks with below-average employment increases and above-average profit gains. The reverse is true for elastic industries. The beta-plus-elasticity strategy is the book's biggest takeaway. In the present Indian context, it's time to make place for elastic, low-beta stocks. With the pundits predicting lower inflation in 2009, the time for stock picking and portfolio churning is at hand.

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