Where’s The Bottom for Stocks?

The Straits Times Index (SGX: ^STI) had hit a 52-week high of 3,550 points on 16 April 2015. In just a few short months, the index has fallen by 19.2% to 2,870 as of the time of writing today (12:37 pm).

If we extrapolate that rate of descent, it won’t take too long before we hit zero. The good thing is, investors won’t see zero. The bad news is, there may be a plenty of space left between here and the bottom. And, it’s not me who’s saying this – it is history.

A painful tumble

When times are bad, the stock market often gets doused with fear. Investors tend to sell their stocks, which causes prices to fall. The falling prices begets even more selling, leading to the creation of a vicious cycle.

The last big crisis Singapore’s stock market faced was the Great Financial Crisis of 2008-09. Back then, at the start of 2009, the Straits Times Index was valued at just 6 times its historical earnings.

While the index is fast-approaching bear market territory (a bear market’s defined as a 20% drop), it’s still valued at nearly 12 times its trailing earnings according to data from the SPDR STI ETF (SGX: ES3). The ETF is an exchange-traded fund which tracks the fundamentals of the Straits Times Index.

Compare the index’s current valuation of around 12 to its valuation at the trough of the last crisis. If we assume corporate earnings in Singapore will stay the same, then it’s quite clear to see that there’s more room for further declines in stocks simply due to them returning to a valuation that was seen in the last crisis. Now, to be clear, I’m not trying to predict anything here – I’m just letting history be a guide.

The dire consequences

Here’s something interesting to consider: What if stocks really do start falling to a price-to-earnings (PE) ratio of 6?

The following table shows what would happen to some of the blue chips in Singapore – like Singapore Telecommunications Limited (SGX: Z74), Starhub Ltd (SGX: CC3), Jardine Cycle & Carriage Ltd (SGX: C07), SIA Engineering Company Ltd (SGX: O39), and Oversea-Chinese Banking Corp Limited (SGX: O39) – if they do reach a low PE of 6.

Company Decline from current share price assuming a PE of 6 for current earnings
Singtel -63%
Starhub -64%
Jardine C&C -39%
SIA Engineering -72%
OCBC -30%

Source: S&P Capital IQ

Now, that’s scary isn’t it? But, it’s important to remember this: The stocks above – and most stocks with viable businesses, in fact – are worth way more than just six times their trailing earnings.

Human psychology often swings to the extremes in the stock market. In bad times, many stock market participants are in a state of heightened fear, which causes stock prices to plummet way below what an informed business owner would happily pay for those businesses.

Standing tall and resolute

The legendary investor Sir John Templeton once said that “The four most dangerous words in investing are, it’s different this time.”

The stock market in Singapore has survived crazy times over the past two decades – think of things like the Asian Financial Crisis, the Russian debt default, the bursting of the dotcom bubble, the September 11 terrorist attacks, the SARS outbreak, and of course, the Great Financial Crisis – and came out ahead. It may be dangerous for investors to think that this time is different and that a recovery will never ever happen again.

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.