Why Does the Stock Market Move up and Down? Part -4



With the fortunate favourable combination of these three factors, the total profit of the listed companies in Malaysia/Singapore has increased by many times. (It is not possible to state precisely the number of times since no one has computed this figure as yet). But the various local stock indices can be used as a guide. The KLSE Industrial Index has increased by over 400 per cent from the beginning of 1970 (KLSE Industrial Index has its base of 100 on 1st January, 1970) to the end of 1987. This represents an average annual increase of 9.9 per cent for a period of 17 years, compared with a GNP growth of slightly greater magnitude. The Straits Times Industrial Index has increased by 700 per cent from its baseline (1 January 1966) to 30th December 1987. This represents an average annual increase of 9.2 per cent over 22 years.

It is to be noted that the 9 per cent per year increase in stock value represents only a part of the total returns received by the investors. In addition to the increase in stock prices, investors also receive a certain amount of dividend per year. There is no exact information on the average amount of dividend received per year. A rough guess would put it at about 3 to 4 per cent per year on average, more in the Sixties and Seventies, less in the Eighties. This means the total annual return for investment in the stock market has been in the order of 12 to 13 per cent per year for the last 40 years or thereabout.

This level of return in the two local markets can be considered to be satisfactory. It is a bit below what has been achieved by most major markets of the West during the same period. Many readers are probably surprised at the level of return obtainable from the local markets over the long run. Most of the players in the market automatically assume that the return from the market is very high. In fact most laymen I talk to seem to believe that the average return is in the region of 20 to 30 per cent per year. But as we have seen, this is far from the truth. We shall be discussing this topic in greater detail in the next chapter.

What Sort of Growth of Stock Market Value Can We Expect in the Future?

To be able to answer the above question, we have to make some predictions regarding the future rate of inflation and future growth rate of the real GNP. To enable the stock market to do as well in the future, the rate of increase in the nominal GNP must stay roughly the same. From the best of our present knowledge, how likely is this to happen?

Let us first consider whether the increase in real GNP can be maintained at the same level as in the past. Much of the growth in GNP of the past 40 years in Malaysia can be attributed to petroleum, palm oil, construction and large foreign borrowing. In Singapore, much of the increase can be attributed to tourism (including hotels and SIA), the financial services sector, petroleum refining, real estate and various light and heavy industries. It looks as if the increase in petroleum and palm oil earnings will increase slowly for the foreseeable future. The enormous amount of construction previously undertaker? everywhere has tapered off as both countries reached a surplus situation in Germs of houses, offices and hotels. The amount of construction it likely to be at a low level for the next 8 to 10 years. In the future, much of the growth in the wealth of the world, will be from electronics and communication; two sectors which may be well-represented in the GNP of Malaysia and Singapore at present but is unfortunately very poorly represented on the stock exchanges. It is likely that real GMl growth for the next forty years will be slower than the 1970’s at around per cent or lower for Malaysia and below 8 per cent for Singapore. Lei us now consider the rate of inflation in the future. As we have seen, we are now apparently in a low inflation era and average inflation for the next 10 years is not expected to be more than 2 to 3 per cent per year, This means that the gross increase in GNP will be about 8 to 9 per cent per year for Malaysia and perhaps about 10 to ll per cent for Singapore. This represents about 2 per cent below the rate experienced during the period 1970 -1987. It is not possible to translate directly this level of increase to a level of increase in company earnings because not all sectors of the GNP are represented by the listed stocks. However, if the past relationship is to continue, a stock market price increase which is slightly lower is likely. This will probably mean a 6 to 8 per cent increase in Malaysia and 8 to 10 per cent in Singapore. These rates of increase would not justify the very high rating given to most of the stocks during the bull market of 1987.


What principles can be learnt from this analysis carried out in this chapter? First, all investors must realize that for the price of a share to be sustainable over the long run, its valuation must be realistic. The return it can provide must bear some relationship to the alternative returns that an investor can get. If the return on fixed deposit (as the most obvious alternative to investment in shares) is 6 per cent, the dividend return of a share must bear some semblance to it unless it is a very special share. A dividend yield (i.e. dividend per share divide by price per share) of 0.4 per cent (as in OCBC’s case in 1973) is definitely not realistic except in very special situations. Second, however high the market may go, however long the bull market may last, the truth will prevail in the end. Very high share prices can only give temporary satisfaction for eventually, its true value will be realized. Third, the market is probably very rational over the long run. Over the long term, the price of shares follow the increase in the corporate profit and dividend induced by the growth of the GNP of the country. if we are long term investors, we should look for companies with good long term prospects that are selling at reasonable prices. If we want to be short term investors, we have to be much more careful because the market need not be rational over the short run. There are possibilities that the unexpected can happen to send the market crashing down. At the same time, short term changes in interest rate and the market.

sentiment can have powerful effects on the market. Unless one is an expert in the prediction of interest rate and market sentiment, it would be risky to go for the short run. All in all, it is much better to be a long term investor.

Long term investment is dependent on the ability to be objective and not be drawn by the sentiment of the crowd. In order not to be drawn into the madness of the crowd, we must develop some way of putting an objective value on a share. At some point during a bull market, we should be able to say: “The market price is absurd, it is time to get out of this madness!” Similarly, we must also be able to say during a bear market: “The market has gone crazy and it is behaving as if company XYZ is on the verge of bankruptcy. It is time for me to buy!” It is very difficult to have adequate strength of conviction to be able to act in complete opposite to the market sentiment. The fundamental approach requires one to sell when the whole market is keen to buy and requires one to buy when the market has totally lost its confidence. Much of the rest of the book is devoted to develop this strength of conviction required of a fundamentalist investor.

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