The Singapore stock market faces a wall of worry
30 May 2002
In today's edition of The Business Times, market watcher R. Sivanithy cites two theories that he claims can be used to describe the current situation in the Singapore stock market.
One is the "golf ball" theory. This theory has a bearish view. When a golf ball is dropped, each successive bounce of the ball reaches a height lower than the last one. When the analogy is applied to the stock market, it suggests a market that bounces to a lower peak at every successive bounce.
Sivanithy's article, however, does not indicate why this theory should be applicable to the Singapore market at this particular point in time, other than the fact that the theory came from chartists discussing the future of US stocks. Technical analysts would be very familiar with the idea that a series of lower highs marks a bearish trend. However, such trends do reverse, and the reversal is only known with hindsight. So the "golf ball" theory is more descriptive than prescriptive, which tends to be true of most chart patterns, in my opinion. In any case, such a bearish trend is not yet discernible in the Singapore market.
The other theory is the "wall of worry" theory. According to Sivanithy, this theory has its roots "in reverse psychology and is grounded in a need to take as optimistic a view of things as possible - even when things are at their most pessimistic". In Sivanithy's explanation of this theory, a worried stock market is a bad thing to the lay investor because it means falling prices and ever-thinning volume across the board, but a good thing to professional traders because prices may be reacting to the worry by over-compensating on the downside. He says that "the over-shooting sets the market up nicely to react strongly on the upside when there are positive surprises or when the news changes from bad to good".
Not for the first time, Sivanithy's take on a well-known concept is unusual. The "wall of worry" theory is actually derived from the saying that "a bull market climbs a wall of worry". The theory explains why stock markets intermittently stall or correct in the midst of a bull run. It explains that economic conditions are seldom perfect, and the future is usually unclear. This is especially so in the initial stages of an economic recovery, when some economic indicators remain weak and many worries continue to dog investors. These worries cause investors to refrain from entering the stock market or exit too soon, even though some economic indicators are improving and market valuations are low. These worries gradually dissipate as time proves them to be unfounded. And as the worries diminish, the market rises.
So the "wall of worry" theory actually has very little to do with reverse psychology or the "need to take as optimistic a view of things as possible". If anything, it is more about the market failing to take as optimistic a view of things as actual economic conditions suggest it should.
Nor is it necessarily a bad thing for the lay investor but a good thing for the professional trader. Rather, it is bad for those who fail to realise the upside potential and exit the market too early and good for those who correctly anticipate further gains in the market and keep on the right side of the bull market through its ups and downs.
Nor is it necessarily about the market "over-compensating on the downside". More accurately, it is about the market under-reacting to the upside potential. Having said that, to be fair, the result is the same in either case: additional opportunity for the investor to take advantage of the upside potential.
Sivanithy also says that "any vaulting over walls of worry can only be accomplished if, as a result of the worries, stocks fall to levels that are considered cheap". Quite right. Sivanithy actually thinks that stocks are not cheap. He mentions that stocks are up 3.75 percent for the year and that, according to UOB-Kay Hian, Singapore Press Holdings, a proxy for the Singapore economy, has a fair value of 20 times earnings, or $20.30, whereas it closed yesterday at $21.40. He also says that the US market is overvalued as well, trading currently at 40-50 times earnings.
However, obviously there are better indicators of whether the Singapore market is cheap. The mere fact that the market is up 3.75 percent for the year is quite insignificant when considering the fact that since the beginning of 2000, the market has lost 32 percent. As for valuations, rather than look at just one company, or at the US stock market, look at the Singapore market as a whole.
The Singapore market is currently trading at a P/E ratio of around 21. By the end of the year, earnings will probably recover slightly, so end-of-year P/E is probably around 19. Neither of these P/Es is particularly low, although they are not particularly high either. State Street Global Advisors, the manager behind the recently-launched streetTRACKS STI tracker fund, has found that over more than 20 years from 1981, the market largely trades within a P/E range of between 15 and 30.
Current dividend yield for the market is about 2.7 percent. Given UOB-Kay Hian's projection of a 4 percent GDP expansion in 2002 and 6.3 percent in 2003, and assuming the market appreciates by the same amount, that implies a total real return of about 6.7 percent for 2002 and 9 percent for 2003. Not spectacular, but not too bad either when compared to bank 12-month fixed deposit rates of around 1.5 percent currently (the latter is a nominal rate, but with the inflation rate so low, it probably matters little). These returns are also close to the 7 percent long-term average total real return achieved in the US stock market (according to Jeremy Siegel in his book Stocks for the Long Run). In fact, in view of the current overvaluation of US stocks, they would probably beat US stock returns over the next few years.
So this brings me back to the position I have been stating since the beginning of the year. At the beginning of the year, I had suggested that the Straits Times Index (STI), at 1,623.60, was too finely poised to call. Things have not changed much since. True, the manufacturing sector grew 8.1 percent in April, but much of the growth has probably been discounted by the market. As a result, rather than reacting positively to the manufacturing data, the STI has been falling recently, dropping to 1684.42 yesterday. What is needed for the bull run to resume is for good economic news to persist into the second half of the year. That is still an uncertain prospect at the moment.
However, here is where the bull market has to climb a wall of worry. Uncertainty has been a recurrent feature of most economic recoveries. Staying out of the market on the basis of uncertainty alone has not been proven profitable historically. On balance, the evidence still points to a continued recovery. More concrete evidence of that recovery is still likely to come over the course of the year. After yesterday's 1.4-percent drop in the STI to 1684.42, the market is likely to consolidate to form a near-term bottom, then slowly climb to new highs for the year probably in the second half of 2002.
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