If history's anything to go by, market conditions could turn volatile

MARKET watchers with a long memory might well have felt a strong sense of deja vu as they watched the collapse of stock markets around the world recently.

The pattern of this global meltdown has, so far, followed the script of a similar painful correction that hit the local stock market in January 1994 - almost to a tee.

And if this 1994 parallel continues to hold true, investors will have to prepare themselves for much more volatile share prices this year, as compared to last year.

As most investors know all too well, the Straits Times Index (STI) slumped by almost 10 per cent in the space of just six trading sessions from Feb 27 to March 5, after hitting an all-time high of 3,310.44.

It then enjoyed an impressive 5.4 per cent rebound over the next four days, leading many market players to declare that the worst was over.

Now compare the events of 13 years ago.

Between Jan 4 and 13, 1994, the STI recorded an 11.2 per cent plunge, after reaching a then record high of 2,471.9 points - as foreign investors pulled out the copious amounts of cash they had poured into the stock market when SingTel was listed. It then recovered 5.4 per cent on Jan 14.

The market then suffered a series of smaller convulsions, followed by short-lived rebounds which failed to revive the great bull run which the market had enjoyed in 1993, the previous year.

Both the recent correction and that in 1994 were anticipated by nearly everyone. But few, either then or now, seemed prepared to accept the inevitable when it finally occurred.

In both instances, share prices had reached levels not justified by fundamentals.

In 1994, blame for the local stock market crash was pinned on former Malaysia finance minister Daim Zainuddin who reportedly said that he had sold all his shares because prices had reached dangerous levels.

This time, a 9 per cent plunge in the red-hot Shanghai stock market on Feb 27 was widely blamed for triggering a global catastrophe that wiped out over US$3.1 trillion (S$4.7 trillion) in the market value of stocks worldwide in just over a week.

So just as the Year of the Pig was looking as auspicious for investors as the Year of the Dog last year, stock prices were mercilessly slaughtered.

Still, coming after a prolonged seven month rally, this recent correction does not yet portend an inevitable slide into a dreaded bear market.

But if the parallels with the 1994 correction continue to hold true, then investors can expect far more volatile market conditions ahead.

There are a number of factors quite capable of giving global markets another nasty jolt. Traders, for instance, have been watching anxiously for any sign of the unwinding of the so-called global 'carry' trade.

This refers to massive loans taken by giant hedge funds in currencies of countries with low interest rates, such as the Japanese yen, to invest in higher-yielding assets elsewhere.

There are fears that a few of these large loans may sour and set off a global financial catastrophe.

That could happen if these funds are caught wrong-footed in a sudden sell-off in which a strengthening yen could turn these loans into crippling liabilities.

Traders who closely track the charts of share prices say that the painful corrections in share prices are likely to follow a 'two-wave' pattern.

After an initial selldown, there is a recovery, known in the trade as a 'dead cat bounce', which may be followed by a second or even third down-draft.

Similar patterns have been observed in major stock market crashes such as the Black Monday crash on Wall Street in 1987 and the Sept 11, 2001 plunge. More recently, it occurred again in May last year and then in June, as turmoil engulfed Asian financial markets.

Last year, so many stocks shot up so sharply that it seemed like a no-brainer to try and make a quick buck on the stock market. The past two weeks have shown that it is just as easy to lose money.

So. looking ahead, it is time to remember this wise market truism: It is best to trade only with money you can afford to lose.

Going by the 1994 script, the market mood may swing from ecstasy - seen as recently as the start of the year as the STI hit record highs - to disbelief as the market takes another grim fall.

There is another, less dramatic possibility. The market may go into a slumber, with daily volumes dropping sharply. Bullishness may give way to caution as despairing traders bail out altogether.

In a nutshell: Investors will simply have to get used to increased market volatility, after being spoilt by the rich gains they had enjoyed earlier as sheer momentum buying drove share prices higher.

And in order to keep their cool - and more importantly their capital and profit - they must have an action plan to cope with any unexpected gyrations in stock prices.

This plan should include a willingness to cut losses if the market goes into a free fall again. Traders should have a 'stop-loss' level - a price below which the pain caused by the depleting value of their investments becomes simply unbearable.

Investors who had despaired of not getting into the stock market last year as it soared to giddy heights may now find it easier to do so.

The best buying opportunities may present themselves when sentiment is at its bleakest. Of course that is a brave call for any investor to make. And they live in hope that pigs may fly.

engyeow@sph.com.sg





Investors must have an action plan to cope with any unexpected gyrations in stock prices. This plan should include a willingness to cut losses if the market goes into a free fall again.