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.
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?