Tuesday, August 05, 2008

The Beauty of a Bear Market

On hindsight, it would have been extremely obvious to a casual observer and a reasonable person that the market would turn bearish this year. That is the problem in general with predictions - they are usually extremely accurate only by looking at history ! However, this post is not to lambast people who attempt to time market cycles (some do get it fairly accurate but are often unable to repeat the "stellar" performance); but rather, it is a post to illustrate how one should take full advantage of a bear market to look for bargains.

I read, with some amusement no doubt, the views of various experts who were asked their opinions on the current market condition. There were varied opinions (as usual) ranging from the optimistic (the bear will only last 12 months and the market is also bottomed out) to the wildly pessimistic (we will get "buried" under a pile of earnings downgrades). It was all very amusing seeing people try to predict the market and to second-guess the economic environment and how long the current sub-prime crisis will last. The fact is that no one knows, yet everyone has an opinion and tries to make an "educated guess", in the process trying to sound intelligent and that they know exactly what's going on. I am not shooting down the opinions of famed investors; it's just that sometimes they should just admit they haven't a clue as to when this will end - I think that sounds more honest !

The beauty of a bear market will only be apparent to people who relish a bear market (usually value investors lah). Most other people see bear markets as something akin to the end of the world, depicting scenarios where people jump off buildings, declare bankruptcy and live the rest of their wretched lives in abject poverty. Such is the media spotlight which is thrown onto bear markets and the media's portrayal of such events. The doom and gloom can get so pervasive that you can hardly find much reason to cheer; in fact everyone is so enthusiastically predicting the end of the world that they fail to realize that opportunities abound to purchase cheaply. In fact, an investor's temperament should be the same regardless of whether the market is in bull or bear mode. He always has to emphasize margin of safety, as well as preservation of capital. Having such an attitude is important as it helps to minimize losses (this is in contrast to people who seek only to "maximize gains").

The Intelligent Investor by Benjamin Graham aptly mentions this point. Jason Zweig who wrote the footnotes for his book writes that without bear markets to bring valuations down to reasonable levels, no investor would be able to purchase with a decent margin of safety. Hence, bear markets are essential for investors and should be welcome with open arms. Bull markets are often dreaded by investors as they do not present suitable opportunities for investment.

That said, one must still be extremely selective in evaluating which company to invest in and to ensure that all aspects of the company are analyzed before a purchase is made. This is because in a bear market, everything looks cheap but the problem is that valuations may not actually BE cheap. During times of economic uncertainty and rising inflation, bear markets will usually occur. This has the effect of weighing on earnings of almost all companies and will throw their growth plans into disarray. Only companies which can pass on the higher costs or find a way around the difficulties will eventually emerge relatively unscathed. Thus, the "cheapness" of a company does not preclude one from investigative work to understand the nature of the business and whether it will be affected by higher costs and/or other economic factors. As a result, finding a worthwhile company to invest in can be a painstaking job and should not be considered simple.

Which is why Warren Buffett said that "Investing is easy, but not simple". The premise of investing is easy to understand, but the actual process to evaluate companies, churn numbers and to understand the workings of the economic environment and how it influenced a company are not simple. Therefore, every investor should work hard so that his/her rewards are well-deserved !

16 comments:

la papillion said...

Hi mw,

Good article :) I think I find good company in knowing your strong stance on value investing - in case my mind is willing but my body is weak :)

muarna said...

Hi MW

Always enjoy reading your articles and have learnt much from them.
what is your opinion on Ezra and Swiber now that oil prices have corrected. I remember Raymond Goh saying earlier that Swiber's prospects would not be affected unless oil drops to below $80. Would now be a good time to purchase both of these stocks since at present prices they do provide a margin of safety?

Patrick Ho said...

Hi, came across your blog by accident, and realise that we hold some similar views on investing. However, would like to ask, what form of valuations do you use before determining whether the share prices are depressed or not? say for e.g. Pac Andes, which is part of my current holdings too.

musicwhiz said...

Hi LP,

Haha no worries I think your spirit and mind are strong as well !

Cheers,
Musicwhiz

musicwhiz said...

Hi Muarna,

I would think Ezra and Swiber are reasonably priced at this level (i.e. not expensive and not cheap) because the original accorded PER was rather high as these 2 companies are seen as "high growth" companies. One can use a simple valuation metric such as PER to assess if a company is over or under valued in relation to the industry/peers and to see if such valuation is justified in light of recent corporate developments.

For Ezra, I do not see any material effects on their chartering business, but I do anticipate some slowdown for their Vietnam yard business as costs have risen sharply in the country. That's one thing you may like to take note of and assume a lower margin for contracts secured there (5% margin perhaps ?).

For Swiber, you may like to wait for 1H 2008 results out on August 13 to decide if the numbers look good and if growth is on track. I still await details on the ED and that is the wildcard at the moment as no details have been revealed of the yard chosen to build this vessel.

Regards,
Musicwhiz

musicwhiz said...

Hi Patrick Ho,

The methodology I use in a holistic one which encompasses reviewing the future potential of the business based on qualitative and quantitative factors. In addition, I also assess the general tenor of the market to get a feel of whether valuations will be depressed or not (e.g. in a bear market, generally you find lower valuations, all things being equal).

Regards,
Musicwhiz

patrick ho said...

Hi interesting,but is there any particular method you try to find if future growth/drop in profits is already priced into the value of the stock?kind of looking for some guidance regarding this;)

musicwhiz said...

Hi Patrick Ho,

Well, not exactly. I will estimate future growth based on potential of the company and apply a discount to the valuation. This gives some measure of margin of safety; but as you said for cyclical companies like PAH it is a little more difficult.

However, you may also like to know that with the ITQ system implemented in Peru, I think the seasonality factor should gradually be eliminated for PAH and CFG.

Cheers,
Musicwhiz

patrick ho said...

oh yes, the ITQ is probably going to put more emphasis on quality instead of quantity, and I think that bodes well for bigger groups like Pacific Andes;) Oh, btw, I signed up for a newsletter from http://www.globefish.org for more updates on fishmeal and fish oil, directly affecting CFG. U might be interested, if u hadn't already done that;)

MakeTraffic said...

Hi MW, Great article (not to mention excellent title!). It is a timely article during this depressed time. A timely reminder to me as well, as last friday's drop almost blew the confidence out of my value investment heart ( i have a weak heart now). Look forward to read your next post. Great blog!

Cheers! MakeTraffic

java_guru said...

My bear has munched on some Pacific Andes at 0.40. Believe it has a decent chance to do really well in the med to long term.

Anonymous said...

I think Warren Buffett says investing is simple, but not easy (not the other way around, as you wrote).

But point is taken, and blog is very good.

musicwhiz said...

Hi Patrick Ho,

Thanks for the link ! I've visited your blog as well and think you articulate yourself very well indeed ! Keep up the good work, shall leave comments now and then where I see fit. :)

Regards,
Musicwhiz

musicwhiz said...

Hello maketraffic,

Thanks for visiting and reading, I appreciate it. Don't worry about the emotional roller coaster of the market, as long as you have a long-term horizon you should be fine. Most importantly, don't let it affect your health..

Take care !

Musicwhiz

musicwhiz said...

Hi java_guru,

Yes I do share your sentiments, though of course we need to maintain a long-erm perspective as the current economic problems are bound to affect all companies. Still, the Ng family have a track record of building the business well, thus I am not too worried and can sleep soundly.

Cheers,
Musicwhiz

musicwhiz said...

Hi Anonymous,

Thanks for the correction. Sometimes I write off the cuff and can't remember the exact quote, hehe. It's helpful to be reminded by readers of my blog. Thanks for visiting !

Cheers,
Musicwhiz