March 29, 2009
Make market cycles work for you
Roughly gauging the stage which equities are in will help investors identify the major trend direction
By Dennis Ng
Observing nature, we will notice cycles.
There are, for instance, four seasons, with the cold winter followed by blossoms in the spring. And just when everyone is having fun in the sun, it is good to be mindful that temperatures will drop as autumn approaches. Those who are not prepared with sufficient clothing might freeze when winter returns.
Similarly in the financial markets, there are market cycles where busts follow booms and vice versa. That is why the 'party' ended with a market crash last year, after global stock prices shot up by between 200 and 500 per cent in the last four years.
According to historical analysis, 2008 was one of the worst years for stocks since 1937. For many, this might be depressing news but for me, this is exciting news. By observing market cycles and investing accordingly, one can try to time the market.
I would say that in the short term, it is difficult to time the market correctly on a consistent basis. However, it is definitely possible to roughly estimate at which stage of the market cycle we are in.
For instance, in 2007, the stock market was in its fourth bullish year. Back then, the Straits Times Index (STI) had risen about 200 per cent from a low of 1,226 in March 2003 to over 3,600 points.
As far as I remember, the Singapore stock market has never had a bull market that lasted more than five years. Believing back then that we were near the tail end of a bull market, I sold most of my stocks and avoided the market carnage that followed a few months after that.
The steps to 'market cycle investing' are simple.
First, we try to estimate at which stage of the market cycle we are in.
Secondly, we try to identify the major trend direction - upwards or downwards.
Finally, we position ourselves accordingly; basically, the strategy to take is to go with the trend instead of going against the trend.
For instance, if you bought stocks during 2004 when the stock market was on an uptrend, it was easy to make money since most stocks were moving up in price. However, when stock markets were in retreat last year, it was very difficult to avoid losing money on stocks, simply because most stocks fell in price in accordance with the general market direction.
Some people firmly believe in the 'buy and hold' strategy, holding on to their stocks through thick and thin, whether the stock market is moving up or down.
I used to be one of them until I realised I lost out on a lot of opportunities by not selling out when markets were high and buying back again when markets were low. We do have to be mindful of opportunity costs. In the last bear market from March 2000 to March 2003, I also observed that when the tide turned, almost all stock prices went down, including blue chips.
Let me give an example: DBS Group Holdings' share price was as low as $8 in 2003; it hovered between $8 and $10 for close to one year. If you practised market cycle investing, and even if you had missed the bottom, you could have easily bought the bank's shares at about $10.
In 2007, after four years of bull runs, DBS' share price shot up to as high as $25 and hovered between $20 and $25 for more than one year.
Again, even if you missed the top, you could have easily sold DBS shares when the price was about $20. By buying at $10 and selling at $20, you would have easily pocketed a 100 per cent return over four years. Not bad at all.
Similarly, by practising market cycle investing, after selling out at $20, and after one year of a bear market, you can now easily buy back DBS shares at less than $10 again.
On the other hand, if you had bought DBS shares at $10 in 2003 and steadfastly held on to them through 'thick and thin', you would have basically enjoyed the 'roller-coaster ride' of the market but would have no profits to show after five years.
Of course, nobody knows when the market will bottom. My experience is that I was early and invested all my money by early 2002. However, I was one year too early as the Singapore stock market bottomed only in March 2003.
Despite missing the bottom by 12 months, I still managed to achieve over 200 per cent in returns riding the four-year bull market that followed.
Thus, by practising market cycle investing, one would inevitably buy when prices are low, and sell out when prices are high.
By doing so, you have also reduced your risks of losing money.
The author is an avid investor and an accountant by training. He co-founded www.HousingLoanSG.com, an independent mortgage consultancy portal, in 2003.