How far can the stock market fall?
A stock market correction, by definition, typically involves temporary pullbacks in share prices of around 10 percent from a recent high within a short period of time.
But the current market downtrend is slowly turning out to be more than a minor market correction as the PSE index, which has already lost by as much as 13.7 percent from its peak in January, seems not bottoming out just yet.
There are fears of larger decline in the PSE index if investors continue to anticipate losses in the coming weeks.
Will this correction eventually transition into a bear market? How low can the stock market go? How long will this correction last?
If market history is any guide, the PSE index can possibly lose some more in a prolonged decline before any significant market recovery takes place.
Based on the past three major corrections in the last five years since 2013, the PSE index lost by as much as 25 percent in eight months in 2015 and in 2013, the market similarly lost about 23 percent in seven months before share prices recovered.
The shortest decline with the least damage was in 2016 when the PSE index lost by 20 percent in just five months before the market resumed its bullish uptrend afterwards.
If the market is looking at the PSE index to fall further toward its 7,400 support in the coming weeks, the total loss would only be 18.4 percent from its recent high this year at 9,078. This could be the quickest correction if the market recovers sharply after hitting this support.
But if historical patterns were to be followed, assuming the market would lose by at least 20 percent at shortest possible time, the PSE index should eventually bottom out at 7,100 level by June or July.
This current downtrend could be one of the major adjustments needed by the market to sustain its long-term bullish uptrend that began in 2008.
Historically, the PSE index has been able to rise stronger, achieving new record highs every time a major market correction occurs.
In fact, all market recoveries over the past seven years have been longer and more profitable.
One example of this case was in September 2011 when the market picked up right after it bottomed out and never looked back in the next 20 months, gaining almost 100 percent in total returns.
In December 2013, the PSE index had a 16-month bull run and made a 42.5-percent gain, while in 2016 market recovery, the PSE index also led a 13-month uptrend that ended in a record high this year with total returns of 39.7 percent.
The current market situation offers great opportunity to prepare for the next recovery. Remember that the first stocks that will recover are those that are part of the PSE index.
The most volatile stocks in the group are the ones that will lead the market. Volatility can be measured by looking at the historical beta of a stock.
A stock with beta of 1.5 means the stock shall rise by 1.5 percent on the average for every 1 percent increase in the PSE index.
The strength of this relationship is measured by the degree of the stock’s correlation with the market.
Based on the last 365 trading days, the five most volatile stocks in the PSE index as measured by beta with about 60 percent correlation are SM Investments (1.25), SM Prime (1.22), Ayala Corp (1.15), Ayala Land (1.25) and JG Summit (1.29). Since these stocks are highly correlated to the PSE index, they are also the most vulnerable during a market selloff.
If the market expects the PSE index to lose more in the short term, buying blue-chip stocks at historically low prices couldn’t have come at a better time.
Over the past 10 years, large cap stocks have generated high returns consistently from capital appreciation with a median return of 14 percent per year.
Highly correlated stocks have outperformed the average annual returns of the PSE index stocks over the years: SM Investment (23 percent), JG Summit (23 percent), SM Prime (19 percent), Ayala Land (16 percent) and Ayala Corp (15 percent).
A falling stock market should not be avoided, but rather should be seen as a welcome opportunity to buy value stocks at a low price and then sell high in the future.
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