What Are the Risks of Crisis Investing? 275 The Psychology of Risk 277

15. An Investment for All Seasons 279

Stock Retums Over Time 280 The Investment Revolution 285 Fighting the Last War 287 Enter the Second Horseman 290 A New Investment Era 292 Investing in Doomsday 292 To Sum Up 295

14. What Is Risk? 297

It Seemed So Simple 297

Other Risk Measurements 303

The Riskless Investments 303

Toward a Realistic Definition of Risk 305

Are Stocks More Risky? 305

Is There Something Wrong with This Picture? 309

A Better Way of Measuring Risk 310

15. Small Stocks, Nasdaq, and Other

Market Pitfalls 316

The Small Company Blues 317

An Attack on Contrarian Strategies 325

We Have a Tie-In to Mecca 327

Should You Give Up on Small Stocks? 329

Beware of Nasdaq and Small Stock Trading Costs 333

The Index Trap 339

Tailor-Made Performance Records 341

Part V

PSYCHOLOGY AND MARKETS 345

16. The Zany World of Rationality 347

The Former Comrades Meet the Market 348 You Can Never Go Wrong in Real Estate 351 The Madness of Crowds 354 Some Common Features of Manias 355

14 Contents

The Characteristics of a Crowd 356

The World of Social Reality 357

The Reinforcement of Group Opinion 359

How Not to Get Rich 361

Here We Go Again 365

Devastating Changes in Perception 369

Not Very Different 369

17. Beyond Efficient Markets 373

MPT Assumptions Revisited 375

Problems, So Many Problems 375

The Crisis of Modern Economics 377

Correlations Unlimited 380

The Vanishing Support for EMH 381

Those Dreadful Anomalies 383

The Jury Is Out Again 385

More of the Same 389

Other Evidence Against Efficiency 391

A Leap of Faith 392

The Problem of Interpreting Information 393 Summing It AU Up 394 Towers Built in Sand 394 The New Paradigm 397

Appendix A: Modern Portfolio Theory 399

The Capital Asset Pricing Model-CAPM 400 Assumptions Underlying the Capital Asset Pricing Model 401

Appendix B: Contrarian Investment Rules 405

Appendix C: Glossary of Terms 411

Notes 421

Index 449

INTRODUCTION

1 HROUGH the summer of 1997 the Dow Jones Industrial Average hit new high after new high, continuing the breathtaking advance it began seven years earlier. It took ninety years for the Average to make its first thousand-point gain. Now it hurdled each new barrier in a matter of months. Since the beginning of 1996 the Dow had risen a staggering 3,000 points, and from the autumn of 1990 it had almost quadrupled.

The rise had caught virtually every expert flat-footed. Back in 1990, most firmly declared that the Great Bull Market that had begun in 1982 was over. A level to moderately down market was the best that could be expected. For years the forecasters were confounded by the rise-although they were loath to admit it. But as the averages exploded, so did their confidence.

By the fall of 1997, the market has become increasingly volatile, plunging hundreds of points in a single session only to more than recoup the loss in the next few trading days. Then on October 27, it plummeted 554 points, the largest daily point drop on record, before again approaching an all-time high in January, 1998. The high volatility continued through the end of 1997 and into the new year. What was going on? In the future, there will, of course, be retrospective answers, or at least you will know what the market did next. But hindsight, in and of itself, has never made an investor money.

Some things were clear to me as I wrote this introduction in the first weeks of 1998. We were in a raging Bull Market, one so powerful that it eclipsed any other of this century. Never before in the 101-year history of the Dow had it risen over 20% for three consecutive years, or quadrupled in seven. Never in my recollection or in my study of previous markets have I seen such widespread investor enthusiasm for stocks-even