Vines summarises the 2008 crash and explains how the markets moved from optimism to widespread panic. First ‘irrational exuberance’ allowed greed to overcome fear as investors paid 15-20 times the book value of stocks. Then, as the US subprime crisis unfolded and liquidity crunch gripped the global markets, fear overcame greed.
There were no buyers even for blue-chip stocks at prices below their book values as panicky investors capitulated. Rationality was forgotten again.
This is where Vines steps in to reassure the longterm investor. He argues that bear markets yield the biggest gains and present a golden opportunity for bargains. His thesis is simple: what goes down must come up. The data of major stock market crashes during the past century shows that every sharp decline in the Dow Jones Industrial Average has been followed by a sharp recovery in the succeeding months. As the past year revealed, investors who entered the market at the height of gloom between October 2008 and March 2009 are sitting on fantastic gains today.
The book also raises an important question—is the market always right? The theory of efficient capital markets is based on the assumption that share price reflects the true value of a firm. But to assume that markets behave rationally is to presume that so do market participants, read investors. This, says Vines, is a shaky assumption, particularly when markets are overheated and include players who have little idea about what they are investing in. Even informed investment professionals may not behave in a rational manner. After all, the global financial crisis is rooted in the subprime loans devised by Wall Street whiz kids in pin stripes.