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| Parallel graphs of the S&P index and price-to-earnings ratio in the S&P index for the same period (Photo credit: Wikipedia) |
Financial IQ Philippines Quick Hit(s):
Since most people are bullish... it's about time to give the stock market a different thinking perspective. You need to see it from the valuation point of view... particularly, as our stock market rose a lot with the help of foreign investments. If foreign investments pull out, we may experience market correction.
Question: Many are optimistic that the stock market will continue to be bullish this year with the index likely to reach an all-time high of 6,500. While this is definitely good news, I am beginning to feel uncomfortable as share prices are already very high. I am not sure if I should buy more or start selling at the current level. Can you advise me?—Gigi F. by e-mail
Answer: If you want to take advantage of the current bullish momentum, you can trade for short-term gain by buying one of the most active stocks and sell it immediately as soon it makes a profit.
This is actually fun but it be can be risky. If the stock fails to move up as expected, you may have to sell it at a loss to recover your cash at once. If you choose to hold on to it in the hope that the stock will improve later, you may risk losing more if the stock suddenly takes a sharp fall.
While it is true that the market enjoys strong economic fundamentals and liquidity flows, the potential for further upside at the moment may be limited as stocks have become expensive by Price-to-Earnings (P/E) valuation.
In fact, the Philippine market, which has market P/E of 19x is relatively more expensive than Singapore or Hong Kong, which has market P/E of only about 12x. To justify the current share prices, corporate earnings must demonstrate exceptional earnings growth to bring down P/E valuations.
If you are deciding whether to buy or sell, consider analyzing this from a risk and reward ratio. Let’s assume the market falls from its current level of 6,055, the immediate support would be 5,866, which gives a 3.1-percent loss. If, on the other hand, the market continues its uptrend and the first resistance is 6,130, you will get 1.2 percent return.
If the probability is high that the market will stop at 6,130, it may not be a good idea to buy at this point because you will risk more in order to gain. It will be wise to start taking profits on some stocks, especially those that have become expensive and invest the cash proceeds to cheaper stocks or simply keep it at the bank until another opportunity arises.
If the prospect of further upside is limited, does this mean that the market may crash soon?
Not necessarily. It only means that the current uptrend may be reaching its terminal phase because share prices are trading well above their underlying values caused by market traders who are bidding shares based on overly optimistic earnings assumptions.
The index must eventually correct itself by falling to levels acceptable to the market. It can fall by as much as 10 percent over a period of time. Corrections are inevitable. What goes up must come down.
In a bull market scenario, any price dip is considered temporary because you expect the stock to recover again. In fact, it is during this time when you take the opportunity to buy back stocks at a lower price for another market run-up. However, if the trend has reversed, any share price rally will be minimal and the selling will continue and possibly accelerate the market downwards.
Do you know that a bull market lasts for three to four years? Our current bull run actually started last March 2009 and it will be celebrating its 4th anniversary this March 2013. Could the end of the bull market be near?
No one knows when this will happen but there are signs that the market is ripe for massive correction. Do you see more of your friends now talking about stock market than in the previous years? Do you see people discussing about stocks more than usual at Facebook, Twitter or online forums? Do you hear radio and TV shows discussing about opportunities in stock market more often than before? Are newspapers featuring stock market news or stories on the front page? Are brokers and fund managers making bold forecast that the index may reach 7,000 level this year?
As more people talk about making money from stocks, more people will get into the market hoping that they will also make a fortune. As buying of stocks increases, people will be chasing stocks and drive share prices above their intrinsic values. Market psychology will tell you that this could be a sign that the party will be over soon.
This is the best time for you to assess your portfolio and evaluate your positions. You may have to reallocate some of your stock investments into other assets for the moment as you wait for the market to correct.
Yes, you will probably feel some regrets as you say goodbye to your favorite stocks for now especially if you see the stock continue rising after you have sold it. There is no way you can catch the market top and maximize your profit. Start selling gradually. Sell while it feels good.
Do not wait for the market to fall before you start selling. You may not be able to sell it at the price you want because you will be rushing to sell down for fear that the share prices may go lower.
http://business.inquirer.net/101969/is-the-ph-stock-market-going-to-crash-soon
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