Survival guide in a difficult market
To make money in the stock market, you need to buy low and sell high. Although this strategy is simple and common sense, most investors including professional fund managers have a hard time following it. Instead, investors tend to buy high and sell low. This is because the stock market is usually expensive when the economy is doing well and cheap only when the economy is encountering problems.
Although many try to buy stocks when prices are falling, a good number sell at an even lower price and lose money as stocks continue to go down, usually making them wonder if their strategy is correct and if the market knows something that they don’t.
The Philippine stock market is now encountering difficult times as the economy is going through a rough patch due to persistently high inflation and global funds flowing out of emerging market equities.
Nevertheless, the market’s ongoing weakness also creates the opportunity to buy stocks at low levels that won’t last forever.
Here are some tips that I hope will help you not only survive but also take advantage of these difficult times, allowing you to execute the strategy of buying low and selling high.
Understand the magnitude of the problem. If the magnitude of the problem facing the economy is severe (i.e. there is a bubble and the economy is at risk of going through a recession), then the stock market could enter into a bear market and drop by more than 50 percent. It could also stay depressed for a few years.
If, on the other hand, the magnitude of the problem is not too severe or is caused by an external shock, then the stock market could drop by much less, around 15 percent to 30 percent, and stay depressed for a shorter period of time.
Although the current problem facing the Philippine economy is more serious than we initially thought, it is still not enough to warrant a bear market that would last for several years. I remain confident the government will successfully address the problem of inflation in the next few months, although it could still get worse in the short term before it gets better.
Buy only when values begin to emerge. As mentioned earlier, many of us rush to buy stocks when prices begin to fall, only to be disappointed and sell at a loss as prices continue to fall.
To protect yourself against this scenario, wait for prices to reach levels that are below their historical averages based on certain fundamental measures such as the P/E (price to earnings) or P/BV (price to book value) ratio which are real bargain levels on an objective basis. Although there is no guarantee that you will get the best price, at least it reduces the probability that you will be wrong when conditions normalize.
Based on the Philippine market’s current valuation, we are already starting to see values. Lots of stocks are already trading below their 10-year historical average P/E ratios. The Philippine Stock Exchange index (PSEi) is also trading significantly below our end-2019 target of 8,100 even after factoring in the current 10-year bond rate, which is already much higher compared to a year ago. This is why we are recommending investors to buy stocks even though economic conditions are still difficult.
Accumulate slowly. Unless you are lucky enough to catch the low, accumulating slowly through peso-cost averaging when the stock market is weak helps you manage risk by improving your average cost. As a result, when the stock market recovers, you will become profitable faster than if you had bought stocks right away.
Pay attention to size. Warren Buffett said, “Be greedy when others are fearful.” But he also said, “Only buy something that you’d be perfectly happy to hold if the market shuts down for 10 years.” Although difficult times create opportunities to buy stocks cheap, risk management through proper exposure or asset allocation is also important.
Given the problems facing the economy, it might take a while for the Philippine stock market to recover. Therefore, make sure the amount of stocks you buy during these difficult times is just enough so that you won’t lose sleep at night or be forced to sell at a loss if the market goes down further or takes longer than expected to recover.
