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How to Profit From Market Downturns

As of today’s close, the Straits Times Index (SGX: ^STI) is at 3,059 points. That represents an 11.4% drop from this year’s high of 3,454 points that it hit in late May this year. With the “official” definition of a correction being a 10% decline, Singapore’s stock market bellwether has been officially “corrected”.

Some of the blue chips have taken it even harder on the chin. For instance, as of yesterday’s close, conglomerate Jardine Cycle & Carriage (SGX: C07) has seen its share price get slashed by more than 39% to S$34.08 from its year-to-date high of S$56.

Some others, such as aircraft servicing firm SIA Engineering (SGX: S59) and stock exchange operator Singapore Exchange (SGX: S68), have fallen from their own highs this year with a similar magnitude as that of the index – the former has dropped by 8.9% while the latter has slipped by 11.2%.

Words of Wisdom

With such falls among the blue-chips taking place all around, it’s perhaps a good time to stress one of the late superinvestor Sir John Templeton’s most famous quotes:

The time of maximum pessimism is the best time to buy.”

Of course, we still have a long way to go before “maximum pessimism” really hits us in the gut. The Straits Times Index is currently valued at around 12 times earnings and still a far cry from the range of around six times earnings it was selling at during its crisis lows in March 2009 when it was below 1,500 points.

You’re not who you think you are

I’m sure most investors now would say they’ll gladly snap up shares on the cheap if the market continues falling. But here’s the rub. Can you really buy when the time comes?

If I were to be offered a bet for a ‘yes’ or ‘no’ to the above question, I’ll prefer to stake my bet on a ‘no’.

Turns out, we humans are susceptible to what’s termed as an “empathy gap” by behavioural psychologists. People are just bad at predicting how they’ll actually feel or act when in a different mental or emotional state.

If you’re starving and being asked out on a buffet dinner date for the next day, you’ll happily agree. If you’re stuffed so full of Christmas turkey and then asked out for a buffet dinner date the following day, you’ll happily not agree, despite the fact that you’ll likely crave the buffet after all that turkey’s digested and gone. That’s the empathy gap in action.

But how does it relate to investing though? Here’s how. When the markets are up, flat, or have just fallen by a tiny bit, fear is likely to be absent and it’s going to be easy to say we’ll buy if shares continue falling.

When shares actually fall hard though – along with other shocks to the economy such as a GDP that’s nose-diving; companies that are entering bankruptcies; or credit markets that are freezing – fear really kicks in and by then we might be paralysed into inaction because we just cannot imagine, when times are good, how fearful we will eventually become when things turn sour.

This naturally leads to the question: What can we do then to make sure we have the discipline and courage to buy in the face of adversity? Here’s where Templeton comes to the rescue.

Templeton’s brilliance

He came up with a brilliant system to prevent his own emotions from taking control in times when he needed a cool and rational head to make the best investing decisions.

Investor Lauren C. Templeton, great-niece of John Templeton, described the system as such in her book about her great-uncle’s investing-genius, Investing the Templeton Way:

No matter how much investors want to distinguish themselves in these tough moments [referring to market downturns], there are psychological challenges to maintaining a clear head during a sharp sell-off…

…One way Uncle John used to handle this was to make his buy decisions well before a sell-off occurred. During his years managing the Templeton Funds, he always kept a “wish list” of securities representing companies that he believed were well run but priced too high in the market…

…Taking this a step further, he often had standing orders with his brokers to purchase those wish list stocks if for some reason the market sold off enough to drag down their prices to levels at which he considered them a bargain.”

Caught the ‘system’? It is the “wish list”, a shopping list of shares that you’ll love to have, but only at lower prices. I know the shares I’ll love to snap up during a market downturn. Do you?

Foolish Bottom Line

Don’t wait to start your own wish list, lest you be caught with butterflies in your stomach the next time the market decides to throw a tantrum and throw the babies out with the bathwater.

I’ll leave the final word to Sir John Templeton, who once wrote (emphasis mine): “To buy when others are despondently buying and to sell when others are avidly buying requires the greatest fortitude and pays the greatest ultimate rewards.”

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.