How to Deal with the Bear Market

After rose 22.3% in 2014, the Jakarta Composite Index (JCI) seems to having a hard time in this 2015. When this article was written, the stock index fell to 4,887 or down 6.5% from year to date. Considering about the poor conditions of national economy (we've discussed about this in this website many times before, try to read our articles since last March), then this situation is not surprising at all, and has been anticipated before (or at least we’ve anticipate it, I don’t know about others). If there is no fundamental change in months to come, then most likely this condition will continue, and consequently the JCI would grow negatively in this 2015. The question, what should we do?

JCI actually has begun its bear period since the end of last April, where it suddenly fell from 5,512 to 5,086, triggered by poor performance on the listed companies in the first quarter of 2015. Because the decline was too much (more than 8% in just a week), then shortly afterwards it quickly rebounded to 5,300’s. But well.. because there are no events that could fundamentally change the outlook for Indonesia's economy in the future (yesterday, the rating agency, S&P, upgraded the outlook for Indonesian sovereign rating, but the rating itself remains unchanged), then it is not surprising that the JCI dropped once again.

In our investor gathering with the theme 'Tips & Strategy to Deal with the Bear Market' that was held in Jakarta, June 23, 2015, I presented at least three main points related to the national economy:

1. The growth of national economy has began to slow down, where most of the listed companies posted a decline in profits, inflation is still high at 6.9% year on year, and the exchange rate of Rupiah is still low at the level of above Rp13,000 per US Dollar.
2. However, we are still far from the crisis. But if there are no changes related to government policy, etc. in the near future, then it is not impossible that the crisis will eventually come.
3. Based on experience, when the economy began to show a trend of slow down, then the trend will not immediately change in the near future, but it could take months or even years to recover (related to the stock market, that’s why we call it bear market, not just a market correction).

Well, I do not know if I've ever said this before, but I will say it again: In the short term, in this case less than three months, the price of a stock can go up or down regardless of its fundamentals (whether it’s good or bad) and valuation (whether it’s high or low). However, in the medium to long term (three months or more, or over one year), the stock price will always follow the fundamentals of the company and its valuation. In less than three months, the share price of Bank BRI (BBRI) or Bumi Resources (BUMI) could go up or down, so that in the short term some people may suffer a loss from BBRI, or make profit from BUMI. But in the long term, in this case the last few years, BBRI has been able to rise steadily, while BUMI, oppositely, down steadily, and it is certainly not without reasons: When BBRI able to posted consistent net profit from quarter to quarter, BUMI continues to suffer losses that eventually makes its equity to be negative aka capital deficiency (so in terms of book value, BUMI currently no value at all).

Logo of Bank BRI, the company with the finest performance in the IDX for the last five years

The same way also applies to JCI: In the short term, the stock index may rise or fall regardless of the performance of the listed companies, and regardless the valuation. But in the long term (or minimal medium), JCI will eventually follow the fundamentals of the national economy. The question, do you think that the businesses in Indonesia are still going well, or indeed a little bit hard lately?

Okay Sir, so are you saying that the JCI, overall, will go down in this 2015? Well of course it is not necessarily. Like I said in this article, the economy will improve in the future if 1. The Government is willing to loosen some of its policies related to the economy (mainly related to subsidies and taxes), 2. The price of commodities, especially palm oil and coal go up, or 3. The developments of the infrastructure be realized. In its best scenario, the economy could grow for more than 5% for the year (from currently 4.7% only), and likewise the JCI will have a fundamental reason to rise back.

But let's take the worst-case: If the JCI is really go down this year, then what should we do?

Before we talk about strategy, if you to look at the historical data of JCI, you’ll find this: Although the JCI will continue to rise in the looooong term, but it could also go down in particular years. Between 1997 to 2014, the JCI closed down 6 times, ie in 1997, 1998, 2000, 2001, 2008, and 2013. Between 1997 and 2001, JCI dropped almost every year because of the long monetary crisis. In 2008, JCI was once again down due to the effects of the mortgage crisis in the US, and in 2013 JCI dropped because the national economy began to slowing down after the continuous expansion for nearly 10 years earlier. We had talked about it in here.

While in other years, JCI rose steadily. Thus, over the last 18 years (from 1996 to 2014), JCI rose in twelve particular years, and fell in the other six. So in average, by not including dividends, the JCI went down every three years. But the switching between the increase and decrease of the stock index was in random pattern. I mean, the JCI could rose steadily for five consecutive years and fell in the sixth year, or conversely, JCI could down for two years in a row, and rise again in the third year.

And believe it or not, if we take the example of the movement of S&P 500 index in the United States as displayed in the Annual Letter of Berkshire Hathaway, the pattern is almost the same. Over the last 50 years, ie between 1964 to 2014, the S&P was fell in ten particular years, and rose in the other forty, also with a random pattern. Longest streak for the S&P occurred between 1990 - 1999, where it rose steadily for 9 years in a row, only to be 'paid off' by a long decrease over the following 3 years.

So it can be concluded that the S&P, in average, was down every five years. However, the data are including dividends. If we take out the dividends, the S&P actually fell more than 10 times, probably 15 times in the last 50 years because in certain years the increases (with dividends included) were only 1 – 3%. Thus, without the dividends, the S&P 500 also went down every three years, just like JCI.

The point is, I wanna say that if the JCI will actually go down in 2015, then there is nothing wrong about that, because you cannot expect the stock index to rise continuously each year, can you? About the current unfriendly economic situation, although sucks, but it's only a part of a cycle. I mean, when the economy grew fast from the beginning of 2000’s until reaching its peak in 2011, you acted like nothing special, did you? So why do you have to complain when the economy is now slowing down?

Okay, but it does not answer the question: As an investor, what should I do in the present conditions?

In an event of investor gathering in Jakarta two weeks ago, I told the participants about three strategies: 1. Quick trading for exploiting the rebound of the JCI, 2. Keep buying shares with good fundamentals (at low valuations, of course), and 3. Just hold your cash and wait, until the stock prices are really discounted. For our own fund, we have sold most of our positions in the third week of April, or shortly before the stock index fell at the end of April, so that we are currently in a free position to apply one of three above strategies, or a combination of all three.

Okay, now let's discuss them one by one, starting from the quick trading. The key is, when JCI is in a downtrend over a period of time, let say for several months, it will not go down continuously but interspersed by rebounds, just like in last May where JCI rose from 5,086 to 5,300’s. Here, we can take advantage of the rebound by buying bluechip stocks with good fundamentals. So you can hold your cash, and wait for another ‘incoming fire’ like what was happened at the end of April. And when the JCI fall for about 7 – 9% in just one week, that’s your buying signal!

And incidentally, when this article was written, the JCI is in another fire, so maybe you could immediately apply this ‘hit and run’ strategy. For those of you who are still holding some stocks, you also can take advantage of the rebound momentum to get out (don’t sell your stock when the index is already fall like today!)

Yet this strategy has drawbacks: We certainly can not predict when the JCI will rebound. If the timing was missed, you may have to sell your stock in losses if the index continued to decrease while you've already take some positions. Some stocks may also not necessarily rise when JCI actually rebounded. Therefore, you may choose the next strategy, which is keep buying shares with good fundamentals at low valuations.

Because, like I said before, when the performance of the listed companies on the Stock Exchange is fairly bad, there are always companies whose performance is still okay, with low valuation of shares. When the JCI falling down, the stocks with bad fundamentals would go down first, followed by stocks with good fundamentals but with high valuations.

While for stocks with good fundamentals and low valuations, in the short term they probably be dragged down, but also probably able to keep going up, or at least stay in their positions. And even if they are dragged down, but in the end they will rise again quickly when the bear period ends (the JCI may drop to any level, but in the end it will rise again). The example of this ‘I don’t give a f*ck about the stock index’ strategy is Metrodata Electronics (MTDL). Between May and September 2013, dragged down by the decline of JCI which fell from 5,200’s to 4,000’s, MTDL also falling from 330's to lower than Rp200 per share. But when the JCI correction ends, MTDL rose back quickly because there was no problem with the company’s fundamentals.

For this strategy, you almost do not need to pay attention to the movement of JCI at all (you could focus on the stock only). However, the problem is, in a condition where the majority of listed companies posted poor financial performance like today, it is not easy to find a stock like MTDL. Okay, some companies had a good performance in the first quarter 2015. But if the recent slowdown in economic growth continues, then who can guarantee that they will still posted a good performance in the next second quarter?

Because of that, you can also select the third strategy: Just hold your cash and wait, of course, while continuing to pay attention to economic developments of Indonesia.

Because, based on experience, when the JCI declining for an obvious cause (this time the cause is related to the poor development of the domestic economy), then the stock market will not be immediately recovered in the near future. In 2013, JCI took three months to get down from 5,200 to 3,900, and stays at that low position for the next four months. In 2008, the stock index also took nine months to get down from 2,800's to 1,300's, before it eventually recovered.

As for this decline, calculated since the end of last April, the correction has been running for one and a half months only. I do not know how low the JCI could fall (actually we have our own estimates, but not to be openly published). But if we look at the current economic development of the country, and also the poor performance of companies, then JCI was supposed to continue to fall in the coming months, once again, if there is no particular event that could significantly change the economic outlooks to be more optimistic.

The third strategy is the most secure, but also the most boring and need some psychological strength, even we can not do it. And it also has its drawbacks: What if it turns out that we are just too pessimistic about the market? What if there is no such bear market? At the end, nobody could predict about the movement of stock index, right?

So we prefer to combine it with the fist and second strategies, for example, by keep holding Sri Rejeki Isman (SRIL) (the second strategy) which, when this article was written, was able to stay in his position despite the declining of JCI.

Of course, when the market is not so friendly, it is very difficult for anyone to make a profit, no matter what the strategy adopted. However, if you loss 5% this year while on the other hand JCI fell 10%, then you actually posted an investment performance that is better than the average performance of the entire players in the Stock Exchange, and the value of your portfolio still have the chance to re-grow significantly in the next year. Just remember, we do not invest in stocks for just this once, but forever. And if this year's JCI does not produce a satisfactory performance, then statistically it is actually good because it will be easier for the stock index to climb up in the following year. At the end, we've done this before, so why worry?

Any inquiries about investment in Indonesia Stock Market? Please send an email to teguh@averepartners.com.