Published August 28, 2008
Straits Times Index, how low can you go?
By R SIVANITHY

Email this article

Print article

Feedback
CONDITIONS in the local stock market are the worst they've been this year, with the Straits Times Index (STI) struggling to hold on to the 2,700 level - the lowest since November 2006. Liquidity has dried up and brokers complain that even though the index is at a 21-month low, large parts of the small-cap segment are faring much worse; China stocks, for example, are at historic lows.
To contrarians, however, such conditions typically make for rich pickings. 'Buy when nobody wants to know' is a strategy that has often in the past proven to yield superior returns when the bottom is reached and prices take a turn for the better. Which of course begs the question: where might that bottom be?
One approach might be to use the duration of previous bear markets as a benchmark.
For example, a reasonable starting point for the regional crisis was July 1997, when Thailand devalued the baht and unleashed unprecedented selling pressure on all regional markets. History has demonstrated that the subsequent bottom for the STI was then reached in October 1998, when the index sank to 800, having had to suffer added selling pressure following the withdrawal of Malaysian shares from Clob International.
That bear market lasted about 16 months; however, the subsequent downturn brought on by the bursting of the dotcom bubble stretched to 24 months - from early 2000 when Nasdaq crashed to April 2003 when the invasion of Iraq ended and the Sars epidemic passed.
If we take the average of these two downturns and arrive at a figure of 20 months and if we assume 20 months to be a reasonable length of time for the economic and financial system to purge itself of the current sub-prime problems, then given that the current bear conditions only really started about 10 months ago, last November, it could be that a bottom might only be reached in mid-2009.
Similarly, Citi Investment Research in a report two weeks ago said that the current bear market could conceivably be two-thirds complete but added that a bear market as long as that seen during the Asian financial crisis is possible.
It also said that although valuations on a price-earnings and dividend yield basis look decent, they aren't that attractive on a price-book (P/B) basis. If a drop in P/B to one standard deviation below its mean occurs, it would take the STI down to 2,410, said Citi.
Another approach might be to look at the charts - which might rankle with the fundamentals-minded but in a depressed market, it's as good a method as any.
Kim Eng's online research unit Kelive favours such analysis and on Monday said that immediate support for the STI is at 2,650 but long-term support lies at the 50 per cent retracement of the March 2003-October 2007 bull run, which is at 2,550.
Possibly the simplest method might be to work out the depth of the most recent corrections to see how the present fall compares.
For example, the STI lost about 58 per cent in the regional crisis bear market and around 54 per cent in the 2000-2003 dotcom sell-off. Those are pretty severe numbers but it's likely that the current downturn will not be as drastic as either of those periods because local companies are stronger and the economy more diversified and resilient.
If so, then assume for argument's sake that a worst-case loss of 40 per cent is possible. If this occurs, it would take the STI down from its all-time high of 3,831 last October to around the 2,300 level.
Of course, all of the above is conjecture and open to plenty of debate. US observers are calling the recession there the worst slowdown since the 1930s, in which case historical analysis using the two most recent bear markets may be inappropriate.
Also, using dividend yields and earnings as benchmarks may prove futile too because of the huge uncertainty that looms over company bottom lines and cashflows in the months ahead.
The best that can be said for now is that although the worst is probably not over, a bottom is also probably not that far off, perhaps within 5-10 per cent of the STI's present reading.
At its most pessimistic, the STI could drop as low as 2,300 - although for this to happen, conditions would have to deteriorate markedly from those prevailing now.