Wednesday, September 19, 2018
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Intelligent Investing

In this bearish market, stay invested, but manage your risk

To make money in the stock market, you need to buy low and sell high. But if this strategy were so simple and obvious, why aren’t people scrambling to buy stocks given that the Philippine Stock Exchange Index (PSEi) is now trading more than 20-percent off from its peak of 9,058.62? On the contrary, investors are starting to panic, with the index now at the dreaded bear market territory.

But for the smart and rational investor, now is a great time to accumulate stocks. Although the Philippines is encountering some challenges, these issues are not enough to justify a bear market. In fact, factors that triggered the stock market correction during the start of the year are already starting to diminish.

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There are signs that inflation could peak soon. After hitting a high of $74.98/barrel last May 23, the price of oil has finally stopped increasing on news that Saudi Arabia’s energy minister Khalid Al-Falih is in discussions with Russia and other Opec nations to increase oil production and ease global supply concerns.

The price of rice should also go down soon given the large volume of rice imports arriving in the country this month. Note that aside from oil, the increasing price of rice was one of the factors that pushed up inflation earlier this year as the staple accounted for 9.6 percent of the consumer basket.

The BSP also finally raised interest rates by a total of 50 basis points in May and June after hesitating to take action during the start of the year. It also said it was “prepared to take further policy action as needed” to keep inflation at bay.

Finally, the negatives are already priced in as evidenced by higher market rates and cheaper valuations of stocks. The 10-year bond rate is currently at 6.5 percent, up significantly from only 5.2 percent during the start of the year. Meanwhile, the PSEi is currently trading at only 16X P/E (price-earnings ratio), way below the 17.9X average P/E during the past five years. Analysts have also revised their forecasts to more conservative levels, which is good because the new forecasts are much easier to beat.

Admittedly, it is difficult for someone who regularly monitors the stock market not to be fearful as the PSEi broke the critical 7,500 technical support recently and fell by a total of 8.8 percent the past two weeks. Even with the growing number of indicators that inflation is peaking, foreign selling was relentless, reaching a daily average of $25 million during the last two weeks, up significantly from the year-to-date average of only $10 million per day.

However, the sell-off during the last two weeks was not caused by any fundamental developments locally but due to prevailing sentiments as other emerging markets also saw their stock markets fall.

On June 13, the US Fed said two more rate hikes were appropriate until the end of the year, bringing the total number of adjustments for 2018 to four.

Meanwhile, the trade tension between the US and China intensified. After announcing tariffs of up to 25 percent on $50 billion worth of Chinese imports on June 15, President Trump last Monday ordered the identification of $200 billion worth of Chinese goods for additional tariffs of 10 percent and another $200 billion more if the Chinese government retaliates again.

In reaction, emerging market stocks fell by 4.9 percent in the last two weeks (based on the performance of the MSCI Emerging Markets Index) due to concerns that emerging market economies heavily dependent on exports would be hurt indirectly by the intensifying trade war between the US and China.

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Emerging market currencies also depreciated by 1.5 percent in the last two weeks (based on the MSCI Emerging Markets Currency index). The peso also depreciated by 1.1 percent during the same period, as the Fed action caused funds searching for higher yields to move back to the dollar.

However, the intensifying trade tension between the US and China should have a minimal impact on the Philippines as we are less dependent on exports compared to most emerging market economies. Unfortunately, the Philippines is part of the emerging market basket, making us vulnerable every time investors reduce their exposure to these markets.

With all these in mind, the smart and rational investor should take advantage of the market’s steep decline to accumulate stocks. That said, we would like to emphasize the importance of risk management.

Nobody knows when the stock market will recover. And while stocks are already cheap, nobody knows when and where they will bottom.

Thus, investors who are buying stocks today should only use long-term money. This is to avoid the possibility of being forced to sell stock positions at a loss because of the need to raise funds for your short-term requirements. Limiting your exposure to a manageable size also helps you stay objective and rational even if the market continues to weaken.

Moreover, use the peso cost averaging strategy and buy stocks weekly instead of lump sum investing or buying stocks all at once. By buying slowly, you will be able to take advantage of any further drops to reduce your average purchase price. This in turn will help enhance your returns once the market recovers.

Finally, diversification is important. Stocks recover unevenly and you don’t want the performance of your whole portfolio to suffer in case you make some bad stock picks.

Although market conditions are scary, experience has taught me that it pays to be bullish and stay invested during tough times. As Warren Buffett has said, “Be fearful when others are greedy, and greedy when others are fearful.”

Now is a perfect time to be greedy, in my opinion.

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