You can never get to the bottom

Published March 12, 2008

MONEY MATTERS

You can never get to the bottom

But markets have fallen low enough such that investing with a two to three-year horizon should net some good gains

By WONG SUI JAU

WAITING to catch the market bottom? It can't be done. But we'll show you a way to take the guesswork out of bottom fishing. You might not be investing at the exact bottom, but the difference is smaller than you would expect.

Stock markets in the region have fallen significantly over the past few months amid much uncertainty and negative sentiment. Yet, there is cause to believe that things will be better in a couple of years. The question is, should you wait until the market heads lower to invest?

The answer is that most people will never catch the exact bottom. Case in point: The Singapore stock market bottomed out in March 2003. Now, how many of you went out and invested all your money in March 2003? Yet, there is a way that you can more or less catch a low in anticipation of better times two to three years on.

This method requires you to divide your money into three to five portions and invest it over the next few months - perhaps once or twice each month. Let's see how this achieves the objective of going in when the market is generally low while controlling your risk if markets were to drop further.

But first, look at the prospects two to three years out. This is important since you wouldn't invest if you think that markets will be worse three years later.

The forecast earnings growth of many Asian markets are all very healthy for the next two to three years, with most Asian countries likely to show earnings growth of over 10 per cent. Asian economies are also expected to report positive gross domestic product (GDP) growth this year and next, despite the weakness in the US economy. Current valuations of various Asian markets are also looking attractive. For example, the Singapore stock market is trading at a forward 2008 price earnings ratio of just 12.5 times, which is very low by historical standards. So, with this backdrop, will negative sentiment continue into the next three years? This is unlikely, and based on fundamentals, we forecast that Asian markets will be higher by that time.

But wait, what if markets remain stable, or they suddenly rise in the meantime? In the short term, we cannot predict how markets will move. So, trying to guess the exact moment when markets have hit bottom is futile.

Let's say there is an Asian fund that is trading at $1 currently. We think Asian stocks have been partly influenced by the negative sentiment in the US and have been sold down even though there are clear signs that the Asian economies are expected to show healthy growth. So, we are pretty confident that Asian stocks are going to be higher two years on though we don't pretend to know how they will do in the next three months. Now, it is certainly low enough to buy into Asian funds if you are planning to hold them for at least two to three years, but what of your fears of markets going lower in the interim? We will show you how splitting your money over the next few months solves this problem.

Over the next few months, the market can either fall, stay stable, or rise.

Scenario One: Asian markets fall another 20 per cent in the next few months. Ouch! So our Asian fund which is currently $1 will be $0.80. But it eventually rises 50 per cent from there, in line with rising Asian markets. So in three years, its price becomes $1.50. The price of the fund falls to $0.80 over next three months before rising again. The bottom is in May.

As can be seen from the first table, in this scenario you would make a profit of over $2,000. That works out to a 68 per cent gain on your investment. You have to fight some fear, though, as your investment drops before it climbs, but you gain the most profit in this case.

Scenario Two: The price of the fund rises to $1.20 over the next three months and continues to rise. The bottom was in March (now): Your profit is much less in this scenario because the market started rising immediately. But a 37 per cent profit over three years is still pretty good. In this case, although you do not gain as much profit, you have the happiness of seeing your investment rise almost as soon as you bought it.

Scenario Three: The price of the fund stagnates at $1 over the next three months and then rises. The bottom is the entire three-month period from March to May: In this scenario, the danger is boredom. The price of the fund does not move for the three months and you may wonder if it was the right time to get in. But you eventually make a 50 per cent profit so there should be no complaints.

As you can see, if you invest part of your money over the next few months, then regardless of what happens to the markets in the short term, you will still come out with gains as long as the markets eventually recover and move up. More interestingly, would it really make that much difference if you used this method versus catching the exact bottom?

As you can see from Table 4, getting the exact bottom does best but the difference is actually not that significant in this example. Anyone who has ever tried to catch a market bottom will understand how difficult it is. If the market is going down or not moving at all, tell yourself to wait one more week, and then another week.

Then, when it rises a little, you will think that it might be temporary because it has not fallen to a low enough level for you. (Incidentally, the 'low' level at which you decide to buy tends to get shifted downwards as the market drops because you have become more and more negative.)

In the end, you will likely buy in at a higher price from the bottom. Or worse, you might never buy as you wait and wait. When the markets are higher, you want them to drop back to the level that you had originally set for buying - but they never do.

So, our view is that markets have fallen low enough such that investing with a two to three-year horizon should net us good gains. By investing over the next few months, you ensure that you get in at a generally low level and when markets rebound, you will be rewarded. Furthermore, investing this way takes the guesswork out of finding the exact bottom and gives you the psychological will to invest in spite of the prevailing negative sentiment. So while you cannot get in at the exact bottom, you can at least be sure that you did buy in low.

Wong Sui Jau (CFP) is the general manager of Fundsupermart.com Pte Ltd, a division of iFAST Financial Pte Ltd.

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