Is it safe to buy stocks at all-time high?

Q: I have been investing in stocks for some time but this is my first time to see the stock market trading at all-time high. Stock prices are expensive. I don’t know how long I should wait before I start buying again. Can you advise me?—R. Perez by email

With the stock market hitting all-time high every day lately, you may have to wait for some time before you start buying again if your objective is to look for bargains. If that happens, the trend may have reversed already and you don’t want to catch a falling knife when stock prices are plummeting heavily. While it is true that stock prices may be expensive, it doesn’t mean that it will stop going up.

Stock prices rise on basis of valuation. Remember price-to-earnings (P/E) ratio? If a stock price is rising, its P/E ratio also rises, making it expensive relative to other stocks and maybe the market in general. Now imagine the market revises its outlook on the stock and expects its earnings to go up higher, the P/E ratio will fall, making the stock cheap again even if the price is already at its all-time high.

This is what is driving the stock market today. Investors are expecting that corporate earnings will continue to do well this year than last year. Of course this also mirrors how positive the market is on our economy despite the political happenings, including the ongoing impeachment trial.

If market sentiment continues to be bullish, the stock market index may continue to register all-time highs week after week. Based on the price chart, the immediate target of the index is 5,400, which is about 400 points away from the current level. The question is—will market fundamentals support it?

Given the current market trend, there are definitely opportunities that you can take advantage of and make money in the process. You can take advantage of the strong market momentum by doing short-term trading. You can buy and accumulate your favorite stock when it temporarily declines and take profits when it goes up again. Be careful not to buy stocks for long-term at this level because stock prices could be very volatile. Bear in mind that as the market continues to climb to uncharted territory, your risk that the stock price will fall sharply also goes up. What goes up must come down as the saying goes.

As the market keeps the good times rolling, there are risks that you should be aware of, risks that may change the basic assumptions of the current bullish scenario. What if the earnings results for first half of this year were disappointing? What if there are changes in economic policies that will upset foreign investors? What if Israel bombs Iran tomorrow and suddenly we have a global oil crisis? Any negative changes on economic outlook will prompt many analysts revise their earnings projection lower, hence making the current market P/E ratio expensive. Investors will use this as reason to cash in on their gains and send stock prices plunging.

Is the stock market heading for reversal soon? Nobody can tell at this point. It will just happen when people least expect it. But there are signs that you should watch out for. When the market is overenthusiastic about everything, this is a sign that the party may be over soon. Do newspapers put stories about stock market in the front page? Are your friends talking about stocks on Facebook more than usual? Are there more people sharing stock market tips at Twitter? Are brokers and analysts expecting the stock index to hit 6,000 level soon? Are expectations of continued robust expansion common among listed companies? Is the percentage of cash investments by mutual fund companies fast declining?

Be on your guard and look for opportunities. When the market declines, analysts and brokers will normally call this a correction. It means that the decline is temporary and they expect the uptrend to continue. At first there will be some denials but if the decline persists and breaks some major market support, then that’s the only time they will face up to reality and call this a trend reversal, meaning the market has reversed from uptrend to downtrend.

If a correction appears to be imminent, the first group of stocks that will be affected will be the so-called blue chips. These are the stocks that constitute the stock index. Examples of these stocks are PLDT, Ayala Corp. and SM Prime Holdings. These stocks move more or less in the general direction of the market. If the stock index goes up, about 60 percent of these blue-chip stocks are also up. But when the stock index falls, you should expect that most of them will also be down.

Diversify your risks by including non-index stocks in your portfolio. Select promising second-liners and even speculative stocks with good story to tell. Do your research carefully. Verify the claims of the story and check the historical trade if there is good market following. When the general market corrects, market players will most likely reinvest their profits from blue chips into the second-liners. The proceeds from the sell-off will provide massive liquidity support to these non-index stocks and you can potentially make some good profits here. If the general market keeps its uptrend, rotational buying will continue and liquidity will simply go back to the index stocks when they are ripe for buying again.

The key in this market is to do the opposite. Join the crowd for short-term gains but do the contrary if you are looking for long-term gains. Manage your risk and reward ratios well. C.C. Hazard of Confessions of a Wall Street Insider says, “The stock market is built on a necessary foundation of error. You make money on the market mainly by living off the errors of other players. Others must die that you might live. The stock market requires an endless supply of losers.” Are you ready?

Henry Ong is a registered financial planner of RFP Philippines. To learn more about creating your own stocks and bonds portfolio, attend the globally recognized Chartered Wealth Manager (CWM) program on May 26-July 7. Inquire at [email protected] or call 383-3790.