Five indicators suggest Singapore market is not overheated

DESPITE the uncertainty surrounding the Trump presidency, fear of the once-in-ten years crash among other things, 2017 turned out to be not too shabby after all - as far as the markets are concerned. The Straits Times Index (STI) advanced 18.1 per cent. With dividends reinvested, the gain is a whopping 22 per cent. Given the pretty strong performance, many investors are fearful of venturing into the market now.

Today, we'll take a look at five indicators which suggest that Singapore market is not overheated yet.

One, the STI's current level relative to its component stocks' average earnings over the last seven years is at the lower end in nearly forty years. As you can see from Chart 1, every time the P/7-year average earnings hits a high of close to 30 times, the market will take a sharp tumble. We are currently at about 13 times.

Chart 1 looks at the earnings capacity of the STI stocks based on their track record over the last seven years. Next, we will look at how the current share prices compare to the assets owned by the listed companies.

If a company owns buildings worth S$100 million as recorded in its books and it has cash of S$20 million and a bank loan of S$10 million, then its net asset is S$110 million. If the company has 110 million shares issued, then each share is entitled to $1 book value of asset. However in the stock market, the share price can be trading at say, S$0.70 or S$2. In the former, the price-to-book (PB) value of the stock is 0.7 times, and in the latter it is 2 times. Everything else being equal, a stock with the lower PB is considered to offer investors better value than the one with high PB.

Chart 2 shows the market median PB at various times. Basically, what I did was to rank all the stocks listed on SGX based on their PBs - from the lowest to the highest. Then I took the stock that is right in the middle as the median PB of the market. I find this to be a pretty good gauge of whether the market is expensive or not. From Chart 2, you can see that if you entered the market when the median PB is about 0.5 times (post Asian Financial Crisis, and post Global Financial Crisis), then you would reap very handsome gains a year later (more than 100 per cent in the former, and about 75 per cent in the latter).

However, if you had entered the market when the median PB is above 1.5 times, in mid-1990s, during dotcom bubble and just before the Global Financial Crisis, then you would have suffered pretty severe losses. The current market median PB now is about 0.8 times, around the same level as in late 2002 and early 2003 during the Severe Acute Respiratory Syndrome or SARS epidemic.

The first two indicators are valuation related. Next, I'll look at two technical indicators. Chart 3 shows the average volume traded per stock in each quarter. The theory goes that in a truly bull market, market activity would increase.

There were five discernible spikes in volume over the past 23 years. One was during the dotcom bubble in 1999. Then there was a small spike in market activities in 2003. That I reckoned was the relief rally after news emerged that SARS had been contained. Next was the rally leading up to the 2007 peak, to be followed by the crash of 2008. After crashing by some 50 per cent, the recovery rally came in 2009. And finally in 2013, we had the penny stocks rally which was again followed by a spectacular crash for the penny stocks. Market activity has picked up in 2017, but not up to a level that typically suggests we are at the tail end of a bull market.

How many stocks actually participated in a market rally is also used as an indicator to tell at which stage of the bull the market we are at. Investors want to see a broad enough participation in terms of the number of stocks advancing to confirm that the bull market has in fact arrived. But if a bull market reaches such a frenzied state that any stock, regardless of merits, also participated, then that's a sign the bull has reached its maturity.

Chart 4 shows the ratio of winners versus losers in the Singapore market. The alerts were given at similar periods as the market activity chart. But this chart has a bit more colour. For example in 2Q1999, according to Datastream, there were 160 winners and only one loser! The relief rally after the SARs and Global Financial crises also registered significantly more winners compared to losers, the ratio is about 10 winners to one loser. But more than anything else, I think the value of this chart is its ability to identify market capitulation. That's when we have indiscriminate selling resulting in significantly more losers than winners. We saw that post Asian and Global Financial crises and after the 911 terorrist attacks in the US in 2001. We have had two quarters of slightly more winners than losers, but not at a scale to raise alert.

Finally, the anecdotal observations. As fund managers, we can tell that stocks are really cheap when people don't want to talk to us at all. Valuations are reasonable when people ask us what to buy (which is happening now). Things are really expensive when people tell us what we should buy!

In one of our discussions, one colleague noted that during late stage bull markets, we will see a lot of young people and older folks opening CDP accounts. But my younger colleague countered that the speculation has gone to cryptocurrencies. It is there that we have frenetic Initial Currency Offerings or ICOs and many lunch time conversations are now about Bitcoins!

There may be valid reasons why the Singapore market is not able to excite investors. Reasons range from lacklustre growth prospects, lack of liquidity to the dearth of exciting companies (there is no IT companies in the index at all!).

Advances in technologies have made it easier for investors to access regional and global markets and to various instruments. It is hard to see a raging bull stampeding through the Singapore market anytime soon. But then, I guess as with most people, I'm guilty of the well-known cognitive bias known as linear projection as well. As value investors, we just pick up any stock which we see as trading below its fair value. The market will surely recognise these stocks' value over time, regardless of whether the stampeding bull returns or not!

The writer is the portfolio manager of Inclusif Value Fund (www.inclusif.com.sg), a no-management fee Asia value fund.