A SHORT DIGRESSION ON WHEN A STOCK IS EXPENSIVE
When investors speak of a share as either cheap or expensive what is actually meant is the price relative to some standard measure of share value because shares are sold at widely different prices. Thus, if a share like International Business Machines (IBM) were to be sold at US$100 most investors would think that the price is very cheap. In order to compare shares selling at widely different prices, we need to use a common yardstick. The most commonly accepted standard measure of value of a share is the ‘Price Earnings Ratio’ or PER (or PE) for short. PER is obtained by dividing the price of the share by the per share nett earnings (i.e. per share profit after tax but before extraordinary items). If the price of a share is $3.00 and its nett earnings per share is 15 cents, the share is said to be selling at a PER of 20 (or 20 times). In the US, PER is also commonly known as ‘Earnings Multiple’. It can be shown mathematically that in a country with a reasonable long term growth rate (say 6 per cent per annum) and an inflation rate of also 6 per cent per annum, stocks should be selling within the PER range of about 10-20 under normal circumstances. In cases of exceptional quality or growth rate, a PER of 30 may be justifiable. On a short term basis (e.g. during temporary earnings decline) high PER can also be justified. It is important to bear this in mind when we later discuss the heights to which share prices reached in 1973 or 1981. We now return to the Crash of 1973.
It is always more difficult to determine exactly when a bull run starts, certainly much more difficult than pin-pointing the time a crash starts. Typically, a bull run always starts gently. The prices tend to bump along the bottom for a while before starting up and even after it has started, there may be a few false starts when the rate of rise would falter. With that caveat in mind, it is my opinion that the bull run started in january 1971 and the big market break (that is the start of the crash) occurred on 13 February, 1973, an up-cycle period of about two years. This means that this rise took place almost entirely within the two calendar years of 1971 and 1972. The amazing fact is that 1971 and 1972 could be regarded as bad years economically for Malaysia while 1973 and 1974 were, in fact, very good years for both Malaysia and Singapore. Yet the latter two years coincided with the sharpest fall in the history of the Malaysian/Singaporean stock market. The Straits Times Industrial Index (hereafter known as ST) fell by 41 per cent in 1973 and 42 per cent in 1974. This fact is examined in detail in a later paragraph.
Until after June 1973, the Malaysian stock market and the Singapore stock market were joint. The whole market was therefore affected by the economic well being of Malaysia. In the early 1970’s Malaysia! Singapore was still very much an export-oriented region. The prosperity of many quoted companies in the Stock Exchange was very much dependent on the export of primary commodities. In the early 1970’s most commodities were selling at very low prices as Shown in Table below:
Prices of Major Commodities
Year 1970 1971 1972 1973 1974 Jan. 1985
Rubber M$/ kg 1.24 1.02 0.94 1.53 1.83 1.90
Tin M$/ ton 10,989 10,442 10,357 17,616 15,075 29,150
Palm Oil M$/ ton 402 573 697 798 902 1,180
It is quite clear from Table above that the good commodity prices were attained after the Crash of 1973 had taken place. In addition, in the aftermath of the May 13th racial crisis in 1969, private investments had been very low. Therefore, overall, the economy of Malaysia/Singapore in 1971 and 1972 was not very favorable. This is quite clearly shown in two of the common economic indicators, namely Per Capital GNP and Money Supply. Per Capital GNP (Gross National Product) can be thought of as the average income per person. Money Supply is defined as the sum of money in circulation plus the current account balance of the private sector and can be thought of as a crude measure of the wealth of the people. The higher the indicators, the better 011″ the people. More importantly, the higher the growth rate of these indicators the richer the people will feel and behave accordingly.
Selected Economic Indicators
Year 1970 1971 1972 1973 1974
Per Capital GNP $ M 1,169 1,169 1,240 1,542 1,829
S 2,404 2,761 3,206 3,849 4,491
% Change Each Year$ M 1,169 1,169 1,240 1,542 1,829
S +12.8 +14.9 +16.1 +20.6 +16.7
Money Supply $Million M 2,033 2,120 2,716 3,755 4,055
S 1,600 1,786 2,413 2,663 2,890
% Change Each Year$ M +8.0 +4.3 +2.6 +28.1 +8.0
S +15.1 +11.6 +35.1 +10.4 +8.5
M = Malaysian S = Singaporean
Again, it is very clear that the Malaysian economy was not doing well until after 1972 (Table Above ). This suggests that the big rise in stock prices in 1971 and 1972 was largely caused by emotional rather than sound economic reasons. If my hypothesis is correct, it is not surprising that the big bull run of 1971/1972 was so very fragile since it was not justifiable in terms of the economic environment of the time.
What were some of these factors which caused the big boom?
(1) Early Profit Was Made
After the May 13th incident of 1969, investors’ confidence sank to an extremely low ebb. There was a very considerable amount of panic selling and the Straits Times Industrial Index dropped to a low of 130 in late 1970 from 170 in April 1969. Many shares were being sold at an extremely low level. The few investors who had the courage to buy then’ were to make hefty gains later on. A year later in 1971, the average price level had increased by over 40 per cent as shown by Straits Times Industrial Index.
Table Below shows the price and price earnings ratio of some examples of stock available in December 1970 and December 1971:
Price and PER of selected Stocks in December 1970 and 1971
Stocks 31.12.1970 31.12.1971 Prices Increase
Price $ PER Price $ PER 1970-71 (in %)
Sime Darby 3.54 12.7 7.70 24.5 117
C & C 1.83 5.8 3.92 9.1 114
Magnum 2.54 12.5 4.28 8.3 69
OCBC 4.50 19.2 7.15 30.7 59
MTC 4.30 14.7 4.84 17.2 13
Singapore Land 0.99 25.4 1.12 21.5 13
As can be seen, the prices were most reasonable on 31 December, 1970 by the normal standard of measure (Le. PER was at well below 20 in most cases) for the stocks shown. This was true for most of the other stocks in the market as well. Even after another more than 40 per cent rise in the overall price level by 31 December 1971, many of the stocks, were still very reasonable, especially the second tier stocks. The early profit attracted a lot more investors into the market and again, the prices rose and by June 1972, ST had increased by another 20 per cent. However from this point onwards, the people entering the market were no longer governed by economic considerations.
The prices were to be increased by yet another 81 per cent in the next six months, after which the end of the boom was in sight. By that time, the market had caught the speculative fever and price rises were no longer rational. The market was to rise another 4! per cent in the final six weeks before collapsing. It is notable that the increase every six months got steeper and steeper. In the final three months or so, the increase in the index exceeded that of the previous two years! This rate of increase obviously cannot be sustained and the speculative mania ran out of steam and had nowhere to go but down. Table 2.4 below shows the rate of increase from 1970-1973 in terms of ST Industrial Index.
Rate of Increase in Terms of ST Industrial Index (1970-73)
Year 31.12.70 30.6.71 31.12.71 30.6.72 29.12.72 13.2.73
ST Industrial Index 139 163 199 239 433 611
Increase per period – 24 36 40 194 178
When a market is rising, everyone who goes in makes some profit and he is therefore encouraged to make further purchases. However, the continuous price increase cannot go on forever. At some point, the amount of money tied up is so high (at the highest, one lot of Overseas Chinese Banking Corporation (OCBC) costs $50,000, a sum which was more than the selling price of two terrace houses at that point of time) that the buyer who buys in anticipation of a further rise will be forced to sell soon if the market is not going up. Once the market sees that a share has stopped rising, the opposite goes into effect. The intending buyer will delay buying hoping that the price will fall further. This causes the weak intending seller to lower his price yet again. A spiral of forced selling at low prices is thus started and it tends to continue at ever increasing speed until eventually much, if not all, of the earlier rise is completely erased.
(2) Many Were First Time Investors
For much of the 19603, investment in the local share market was very much limited to the institutions, large corporations and a few well-off private individuals. The middle class was of a small number and wielded little economic power. However, with Independence in Malaysia and Singapore, the social spending of the governments were vastly increased and slowly at large body of middle class consisting of civil servants, doctors, teachers and other professionals was established.
Like the US of the 1920’s investment opportunities in the late 1960’s were limited. Three months of fixed deposit was then paying 5 per cent interest. Naturally the stock market attracted some of the money in circulation. As explained earlier on, those who made profit early attracted many others into the fold. The commentators of the time also pointed out an additional fact which caused a large number of first timers to move into the market. In late 1972, all teachers in Malaysia received a considerable amount of back pay. The sudden receipt of an unexpected sum of money and the booming stock market at that time was all that was needed to push many teachers into the market. indeed in 1972, teachers’ common room conversation was largely limited to the stock market.
These first timers had little idea of the economic principles upon which stock purchases should be made. Instead they relied on market talks, brokers’ advice and self-proclaimed ‘experts’. As a well-known Wall Street saying goes: ‘Genius is a rising market’. The rapidly increasing prices gave all involved a vision of boundless prosperity and wealth. By the end of 1972, price rose to a level which could not be justified by any known economic standard. Table 2.5 below shows the price of several market favourites at their highest and on 31 December 1971.
Prices of market favorites at their highest and on 31 Dec. 1971
31.12.71 Highest Price
Price PER Price PER Increase (in%)
Dop Bank of Singapore 1.24 40 11.20 203 803
Malayan Credit 1.69 10 19.50 273 1,054
OCBC 7.14 24 50.00 159 600
Singapore Land 1.12 11 12.50 271 1,016
As can be seen, the price increase obtained were totally out of the bounds of rationality. A PER of three digits is absurd by any standard but to the newcomers, PER was a meaningless measure. All they believed was that: ‘If the prices had doubled in the past six months, they must be capable of doubling yet again in the next six or even three months’.