Sunday, February 8, 2015

What should you be doing in the current market conditions?

We are undoubtedly going into the 6th year of the bull run since the Great Financial Crisis last happened in 2008/2009. The STI index last ended at 3,431 and the momentum is clearly on the way up. I have no idea on where it is going to go by the end of the year but I do sense some things that are happening lately, at least amongst the local scene.

Market participation seems to appear more rapidly from new retail investors either from the local blogosphere or investment forums across Singapore. You see a lot more investment seminars being touted across the public and obviously it is a good time to do so when market is in a positive and buoyant mode. SGX also hold an investment carnival over the weekends at Cathay Cineleisure to encourage the younger public from investing in shares. 

The timing of the SGX to launch 100 shares at this time does provide some excuse (or reason) for that. It seems like there's never a time easier than now to start investing and I can see how this has impacted the local scene. I have personally not been a fan of this launching of 100 shares, especially at this time as it doesn't give the public sufficient time to prepare for an in-depth research before entering the market to invest. Think of it this way, if it only costs you $800 to buy 100 shares of Keppel, I wonder how much effort or due diligence retail investor has sufficient perform beyond the 52 week high/low or the everly popular PER type of valuation methodology. The mind would be thinking 1.) Oil is currently at extreme low price; 2.) Everyone is talking about the stock and therefore I must own some shares too; and 3.) I can afford it. This doesn't mean that Keppel will not go up to generate profits for the investor who are vested in the stock. It just means that the level of preparation for the investor who lay an initial capital of $800 is genuinely different from one who lay an initial capital of $8,000.

In other words, I don't think the public is ready to face a downside bear market scenario when that happens (who knows when?). The recent fall in O&G stocks may provide a false prelude that the investor is ready to face a bear market scenario, but in all fairness we are only speaking about one industries in general. That same investor would probably have time to rebalance the portfolio by selling other industries that were not affected (e.g transportation) and switched to the O&G counters. However, imagine if it were to happen during a bear market when all industries and all companies are facing a massive drop all at the same time. You wonder where you get the capital to rebalance your portfolio using the same strategy you used previously.

Capital preservation is one of the key important element to note during a bear market. If you lose 50% of your portfolio during the bear market, it takes 100% gain to breakeven.

What should you be doing right now?

Researching and analyzing companies should never had been a one-time process that you do only when you are ready to buy. In fact, the best time to do it is during a bull market scenario like it is today so that you are fully aware of the current valuation versus a valuation that you are comfortable to enter during a market pullback.

I have not been buying a lot of new counters recently but I have kept my research on an ongoing basis so that when the market has pullback to valuations low enough, I would be the first ready to enter with my capital. For example, I really like Silverlake as a company with strong earnings yield and balance sheet with incredible business moats. But when it is trading at current valuations of 29x PER and EV/EBITDA of 25, I stopped and ask if the growth is already priced in. Heck, assuming a dividend payout ratio of 50%, we are talking about 58 years just to get your money back based on dividends alone. I will be 88 years old by then!!! Anyway, I will put this in my watchlist and get ready to enter should there be a pullback in the overall market.

Speaking of capital, you need them during a market pullback. In fact, you can do tons of research but if you don't have capital during when you should be buying, it's pretty much useless. Cash is king when that happens. There are a couple of ways you can do this.

1.) Portfolio Allocation

Most investors who hold a proper asset allocation would have done rebalancing on a periodic basis. In other words, when stock market valuation is high, sell or switch them to either bonds or cash, depending on whichever you like. The idea is to reduce your stock allocation beyond what is required to maintain the portfolio.

2.) Save up cash for warchest

If you are working as an employee, you can diligently save up each month of your salary as cash for building up the warchest. Even though cash yields you like a loser right now, it might come in really handy when everyone doesn't have it and you have it like a king.

3.) Dividends as alternative cash-flow

The other alternative is to build up sufficient amount of cash-flow by investing in dividend paying companies so that your cash-flow would come in handy during a market pullback. Do note that during a severe market condition, defensive and dividend paying companies are not spared but the dividends could at least be re-invested back into the company at a lower valuation.

Final Thoughts

I'm not trying to predict where the market is going from this moment into the future. I think market timing has proven to be incredibly silly and it appears really difficult to do so consistently. I also do not discourage anyone from entering the market right now, as high can always go higher. In fact, buying high and selling higher is a pretty smart strategy if you can enter and exit successfully.

What I was trying to do is to sufficiently prepare myself for the worst case scenario, consistently review the holdings in my portfolio, build up sufficient cash-flow for working capital and warchest and pray that I would be sufficiently prepared during a market pullback. 

I have not experienced a full bear case scenario and cycle like what happened back during the GFC and I will never know how much preparation is enough, but at least I know that it is going to come one day.

So always be prepared - It is always better to predict the worst than being an optimist. The worst is yet to come. Now if you excuse me, I'll sit on the sidelines while the music continues. Sorry to disrupt your parties.

What about you? How are you preparing for a market pullback scenario? Look at your own balance sheet, are you sufficiently ready to tackle a bear market?


  1. The way I see it, the stock market doesn't exist. It's there only as a reference to see if anybody is offering to do anything foolish. Some of my best returns were made when the market was at its high. So there's always value, I just have to look harder when everything is pricey.

    1. Hi Henry

      That's what everyone ought to be doing actually. Focus on the business rather than the economy. But there's no doubt that it's much harder to find value in the bull run scenario.

  2. Hi B,

    I did a simplistic test

    If someone is saving cash every month, that is ready for deployment into investment, I felt that the need for active shifting of equities into cash might not as strong as in the case where the pot of money is fixed. The cash proportion will continue to increase vs equity as one do nothing anyway.

    I believed warchest or regular savings both works, a combination of both also works.

    Only one thing does not work. Panic selling during bear and you freeze during bear, always waiting for the new bottom.

    1. Hi B,

      just to be clear, I am not advocating fully vested, just that I am not a fan of War chest approach (Big cash waiting for crash of market), I am hybrid...

    2. Hybrid means cash-stock allocation of 50-50 or 40-60?

    3. Hi CW,

      I am not advocating anything, but for me, if the O&G didn't go bonkers, I would most probably be 30-70, now, I am fully vested, waiting for chance to take profits off some counters.

      Think the highest I would go is 40-60, which is very unlikely unless in a super bull euphoria

      50-50 or higher, to me, is already warchest approach.

    4. Hi Sillyintestor

      Thanks for your article link.

      It's interesting for your exercise because for the first case you are taking the median range of STI as an entry point. At some point this will either be higher or lower and if the index consolidate at the peak, then more entry could be at the peak instead.

      Hybrid is still the best because you have both on your hands and can't lose out no matter what happens. The percentage is up to one's appetite and see if one can stomach the downside when it happens.

  3. treat your stocks and cash as allocations and do regular rebalancing. your problem would be that you may see as cash not having value. if you look at cash as a call option, then perhaps u will feel better to accumulate the call option when they are prized very low.

    rebalancing is an auotmatic buy low sell high.

    1. Thanks Kyith.

      Indeed, if we see cash not as a low yielder but as a call option, the mindset completely changes.

  4. Hi B,

    Personally, I see 2015 as a bull market even though it may not be as strong as 2014. I haven't made much purchases lately seeing how many stocks I am interested in are at a high point right now. Even the oil sector is starting to recover this month. Despite the recent dips in oil, my portfolio is too heavily focused on oil right that I don't really feel like buying more even though logic dictates that I should be. Instead, i'll take your advice and stop saving up cash for when the bear market comes.

  5. For me, I think the important thing is to have a strategy in place and know the reasons for our current portfolio allocation. Its a tough balancing act. Who knows when the bull market will end? For those who's fully vested, given the right strategy and mindset, perhaps they are able to take advantage of the bull run now and accumulate more cash to buy in during the downturn. However these people run the risk of having their money tied up during the crash as well. For those who kept more cash now, there might be some opportunity costs involved currently, but perhaps they will have more flexibility and are better positioned to take advantage of Mr Market in the event of a crash.

    I think there's no right or wrong way but its important to make sure we have a logical strategy in place and be mentally and psychologically prepared to follow this strategy when the time comes.