Tuesday, September 13, 2011

Blood on the Streets

We have to digress from our topic on education a bit as the financial markets are entering interesting times. Here is my attempt to answer a question on many people's mind: time to buy?

The last couple of months were pretty awful for those who are involved the markets. Most indices were down double digits. Europe was down 20%, Asia high single digits and Latam was also down teens. Only US did ok with single digit declines. What an irony, US the birthplace of this current mess actually suffered the least…

Market commentators are talking about 1/3 chance of recession, but I believe the reality is that we are already in recession. It is double dipped chocolate with whip cream. Unemployment no.s are going to rise and real assets are likely to fall (finally! A chance to buy property!), hopefully.

So the big question: when is it time to buy? Now or still must wait?

Well, I must admit, I am THE worst market timer, so I won’t answer that question outright. I would say look at valuations. If the valuations look cheap enough, then probably it’s ok to buy. But if we go into a recession, things will get cheaper. Value investing cannot help you time the bottom. Market idiosyncrasies can bring a PB 0.5x stock go to 0.3x, even when the book is perfectly good, with no impairment, write-downs or other balance sheet risks.

So the trick would be to keep some bullets. This is for those with ample liquidity who can afford to buy a bit now, wait for more blood on the streets and average down. Not forgetting, there would be transaction costs involved too!

Why do something like that? Why not just wait for real bloody mess and then bet the house?

Well for those who have gone through Lehman or previous messes, we know it’s easier said than done. First, something like Lehman might not happen. Markets might not fall further bcos it is already pretty cheap (at least some markets are, like Brazil which are at single digit PE and giving 4% yield). So if we didn’t buy now, we might miss the boat before we even realize.

Second, when it does come, we don’t dare to buy, bcos we think it’s the end of the world, better keep cash or gold. And when things recover, again, we miss the boat. Of course, the 2nd lesson learnt here would be that if Lehman does happen again (ie global markets fall 20% in one week), we just have to bite the bullet and buy.

Ultimately stock markets will recover. Stock markets have survived the Great Depression, Wars, Oil shocks, Hyper-inflation etc. The only exception is Japan which is mired in major issues which deserves a couple of posts to discuss. But I guess it is the safe to say that as long as companies meet their cost of capital (which most of them do), they would continue to create value for shareholders and that’s the reason stocks will continue to go up over time.
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