What to do now that the bear has reared its head
After the local stock market’s historical price-to-earnings ratio ( P/ E) had reached levels just short of 19.5 in April this year – and most experts felt that the FTSE/ JSE All Share Index (Alsi) still had more than enough room for improvement – the markets decided that this month was the time to bring the share prices in l ine with the actual earnings of the underlying shares (see my analogy in Focus on the earnings, not the share prices, 9 April edition). At the time of writing, the market is down by 8% so far this August and down 13% since its all-time high in April, making it safe to say that we now officially find ourselves in a correction.
One of t he st rongest technical indicators, the ‘Death Cross’ (50-day moving average breaking the 200-day moving average and closing below it), has since come about. In technical terms, this means that we have turned from a bull market to a bear market, which isn’t seen as a positive sign for technical analysts and their followers. The big question, however, is whether this is merely an overreaction, or perhaps an indication of greater troubles to come.
I stil l feel that the market isn’t cheap and that it remains overvalued by approximately 15%. Following the occurrence of the Death Cross, the moving average of the weekly close over 200 weeks may be tested, which would correspond with the fair value levels (in terms of earnings per share) of between 42 750 and 43 300 on the Alsi. Although the data and results concerning emerging markets do not look very promising, I don’t think it’s bad enough to be seen as a repeat of the 2008 correction. I think it can be seen as more of a ‘ healthy’ correction, rather than a total collapse. FTSE/JSE All Share Index and Fair Value
EPS Model “Fair Value”
FTSE/JSE Top40 Index
SOURCE: PSG Old Oak, INET BFA SO WHAT CAN WE DO IN THE EVENT OF THIS BEING A ‘HEALTHY CORRECTION’, WITH THE POSSIBILITY OF HITTING EVEN LOWER LEVELS? 1.DEEP BREATHS Keep your emotions out of your investments. If you bought shares within your particular risk profile based on an appreciation process that indicated that these shares should provide you with the appropriate growth and earnings over the long term, you will just have to lie back, be patient and breathe deeply.
diversification – not only across different companies and sectors, but also across different asset classes. Warren Buffett mentioned that investors shouldn’t shy away from hiding in cash every now and then. I personally feel that negative markets present you with the perfect opportunity to ensure that your portfolio diversification is still in line with your risk profile.
FTSE/JSE All Share Index with 200-day and 50-day moving average
30 000 FTSE/JSE All Share Inde 50-day moving average
200-day moving average
SOURCE: PSG Old Oak, INET BFA are starting to offer good value. Look for companies that do not have excessively high ratings, that pay high dividends (which have been well maintained over the long term) and do not have high debt levels. There probably isn’t such a thing as a ‘good correction’, but the fact remains that a correction is as much a part of the stock market as butter goes with bread. As such, use this correction to get your portfolio back in line and to ensure that it remains ‘healthy’.