Why You Shouldn’t Trust 2015 Outlooks for the Singapore Stock Market

We’re near the start of 2015 and this is the time when market outlooks for 2015 from various brokerages start flying off the shelves. Naturally, there’re a range of opinions about where Singapore’s stock market is headed to by the end of the year.

But by and large, it appears that the general mood for 2015 amongst the local broking houses can be summarized by the title of a recent Business Times article – “Broking houses upbeat on Singapore market, citing cheap valuations.”

The SDPR STI ETF (SGX: ES3) – an exchange-traded fund which tracks Singapore’s market barometer the Straits Times Index (SGX: ^STI) – is currently valued at 13.5 times its trailing earnings. When compared to the Straits Times Index’s long-term average price/earnings (PE) ratio (from 1993 to 2012) of 16.6, it seems fair to label Singapore’s stock market as “cheap.”

But, if anyone’s saying 2015 will be a good year to invest because of low valuations alone, then you ought to be wary for a simple reason: Cheap shares are no protection at all from horrific short-term performances.

Investor Kenneth Fisher and finance professor Meir Statman once looked at PE ratios in the U.S. stock market at the start of each calendar year from 1872 to 1999 and found that “there is no statistically significant relationship between P/E ratios at the beginning of a year and returns during the following year or during the following two (non-over-lapping) years.” Put another way, how cheap shares are now can tell you nothing about their returns over the short-term future.

A pictorial representation of what Fisher and Statman meant can be found in the chart below, which plots the S&P 500’s (a broad U.S. market index) cyclically-adjusted price-earnings ratio against its subsequent one-year return. The data I’ve used stretches from 1871 to 2013, so that’s again more than a century’s worth of history we’re learning from.

S&P 500 annualised return (1-year period)

Source: Robert Shiller’s data; author’s calculations

The randomness in the data points to how the stock market is essentially a dice-throw if we’re depending on short-term returns (a very low CAPE of less than 11 can result in a one-year loss of 31%!). Notice how the chart changes though, if we stretch the holding period to 10 years.

S&P 500 annualised return (10-year period)

Source: Robert Shiller’s data; author’s calculations

A lot of the randomness gets taken out and a much clearer picture emerges: Buy cheap shares for the long-term, and you’re likely to get a good outcome.

It’s imperative that you keep this in mind and set rational expectations when you start looking at market outlooks for 2015. Cheap shares are a great thing for us – but only if we’re willing to ride it out over the long-term. On the other hand, cheap shares can be useless if we’re investing for time spans measured in months (or one/two year increments) because as we’ve seen, investors can still suffer painful short-term losses even with low valuations.

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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 company mentioned.