Book Review: Speculative Contagion

Speculative Contagion is subtitled "an antidote for speculative epidemics". The book essentially comprises edited reprints of the extensive commentary provided by Frank K. Martin to clients of Martin Capital Management (MCM) during the period from 1998 - 2004 which covered the tech boom and subsequent bust. The final section is a list of key principles largely drawn from their experience during this time. MCM actively manages client portfolios using a value based stock selection philosophy. At times they will be heavily invested in cash while they attempt to identify investments which meet their criteria.

The commentary makes for very interesting reading. Several key ideas can be drawn from the commentary:

1. it is better to miss out on a speculative boom than to be caught in the subsequent collapse : of course it would be even better if you could catch the upside and get out soon enough to avoid the worst of the bust which is what trend followers would attempt to do. Perhaps the better lesson is to avoid being caught up in the euphoria of a speculative frenzy;

2. modern portfolio theory and the efficient markets hypothesis are wrong: while the jury is still out on this one, unless I could persuade myself that I could really out perform the market, low cost indexing is still the safer option for me;

3. the lessons of history are valuable to investors: this has to be correct;

4. high return and low risk go together: this argument is persuasive. Essentially, if you the price you pay relative to valuation is sufficiently low you effectively lower risk while generating the possibility of a higher return at the same time.

If I took one lesson from this very interesting and entertaining book, it is the value of patience. When it comes to investments this is something I am often sadly lacking.

I am not persuaded that stock picking is the right approach for myself (or indeed for most individual investors) for the simple reason that by definition only half the investors can beat the market averages and I have no basis for assuming that I can compete with the legions of professionals attempting to do the same (even assuming I had the time to make the attempt). That said, I remain very sceptical about the validity of the efficient markets hypothesis and modern portfolio theory. Even as a small investor with limited resources, I should have the common sense to stay out of grossly over priced markets and to invest more heavily in markets which look fundamentally cheap. The emphasis here is on the market or asset class rather than the individual asset.