I’ll pen a quick few thoughts about what I see in the current bear market environment.
Most investors are aware by now that bear markets are part of investing in the stock market. This is partially because one of the more recent and worst bear market condition occurred not too long ago in 2008 so a lot of investors are mentally more prepared for this. Many of them are referencing the GFC crisis as a benchmark to what they are experiencing right now and it’s not necessarily a bad thing since the situation back then was pretty bad. For example, I hear many people are awaiting for OCBC to drop to $4 (GFC low) before they are willing to put their money. Whether or not they are right there, at least it is rather conservative.
The above situation also leads me to think that there are a lot of investor’s focus on price rather than valuation. Taking a similar example on OCBC, it is somewhat quite different when their price was $4 back then versus $4 today. If you are a believer of fundamental analyst, you would understand what I meant by that. However, if you are a trader, you would probably be looking into that as a major base support line. Again, only hindsight will prove the right one.
During this bear market environment, indexes can also remain oversold longer than most dip buyers could remain solvent. What I thought was a cheap buy could actually be cheaper if I waited longer. This is because in bear markets, short setups often continue to push the price down even during oversold conditions. Perhaps, I would also need to adjust my personal version of margin of safety that are different when markets are in a bull run by discounting them more during this period. That’s something that I am still trying to learn.
As academic have taught us, we are also used to using trailing twelve months (TTM) historical earnings to forecast the company’s next 5 years earnings. This can be fatal because the past 5 years are probably good times which might not be repeated during uncertain economic conditions. For cyclical companies, it is better to normalized the earnings through the trough and peak to capture the full impact of the cycle. For other companies, it may be good to use conservative earnings during the recessionary period to forecast future earnings. The objective here is to ensure that we are not blinded by optimistic returns without thinking of the downside.
During the current market condition, I also experienced a situation where there are more choices of stocks that appear in my watchlist than before. This is because during bear market, all stocks are not spared and the share price will plunge giving investors plenty of choices to choose from. Do we go with companies that are able to maintain their strong earnings but having their share price not down much? Or do we go with companies that have their earnings battered so badly that their share price followed concurrently (e.g Keppel, SCI)?
Because of the above situation and our limited cash resources, investors are always faced with the one-decision, two-decision and three-decision during bear market as what Charlie Munger have pointed out. I am guilty of that myself.
- One-decision – This is when you decide to buy a stock when their fundamentals are strong or sell because fundamentals have weaken. This is what a value investor usually does and they usually have the intentions to hold these companies for an infinite period of time.
- Two-decision – This is when you decide to sell your existing position in favor of another stock that you think will reward you with greater returns in the long run. The decision to sell may or may not be due to fundamentals but more of limited resources to take advantage of the opportunity in the market.
- Three-decision – This is when you decide to sell your existing position in favor of awaiting for a better entry price for the same existing position because you think the market conditions will push the price lower. This is called a three-decision because you sell and think the price is full, then you have to figure out when to buy back, and in the meantime face the dilemma of whether another opportunity might come up or if you might miss re-buying into the position should the market reverses upwards.
Howard Mark, in his latest memo, wrote this in his article which I really like a lot. He said, Up or down, the market has no special insight which conveys no consistently helpful message. It’s not that it’s always wrong, it’s just that there’s no reason to presume it’s right.