By Hopeton Morrison, ContributorTHE index of the Jamaica Stock Exchange (JSE) has seen some correction over the last six weeks or so. The index rose to an all time high of 109,888.26 points on April 29, this year. Since then it has retreated a bit, closing Thursday of last week at 96,752.72 points or a drop of approximately 12 per cent.
This type of movement in the market is absolutely normal and when the market retreats such as it has over the last six weeks, this is known as a correction classically defined as a 10 per cent drop usually occurring once a year. This correction was almost inevitable.
For the first quarter of this year our local market experienced a phenomenal and unprecedented bull run that was unprecedented in our situation. When the index crossed the 100,000 points barrier on 'All Fools Day', April 1 this year, this event generated considerable excitement and typically prompted a number of new and returning players to enter or re-enter the market, some in an attempt to 'make a quick killing'.
UP AND DOWN
A question frequently asked by those new to the markets is why does the market go up and down. There are many reasons. Those driving our local bull run have all been well documented by various analysts and include some of the reasons outlined below.
First, cross-listed stocks (stocks listed on the Jamaican, Trinidad and Tobago and Barbados exchanges) have been driving the market. Secondly, companies have generally shown healthy growth in profits for the financial year ended in December 2003. Thirdly, with interest rates on fixed income instruments on a downward trend that has been fairly sustained over the last 14 months it now appears that investors are starting to believe that the usual volatility in rates that has characterised our economy in recent times is bottoming out.
These rates are now in the mid to low teens and with the Net International Reserves (NIR) strengthened, few investors it seems are prepared to 'test' the Bank of Jamaica's (BoJ) clear intention to aggressively defend the dollar against all comers.
Resulting from this, real returns on some fixed income securities have now slipped into the negative zone for investors. With inflation for the fiscal year (March 2003-February 2004 running at 16.2 per cent), after tax returns for these are now below the inflation. A fourth reason is that the recent World Bank report that positioned Jamaica as being one of the 10 top countries in the world providing favour-able business facilitation is a very big deal indeed and would be hardly insignificant to the international investment community. Indeed, there is a school of thought totally independent of the political constituency which holds that Highway 2000 and new expansion plans for bauxite, tourism, and information communication and technology could be a precursor to a period of sustained capital investments in Jamaica as occurred prior to our independence.
A fifth reason is that the economy appears now to be on a sustained growth path with the Government scoring major economic successes highlighted by the fiscal deficit target (-5.8 per cent) achieved against all expectations, a primary surplus target of 12-13 per cent achieved, and GDP growth of 2.2 per cent (following on 1.9 per cent last year and positive projections for fiscal 2004-2005) especially with the latest report from the Conference Board forecasting continued growth in the economy for 2004.
All of this hardly mitigates the overarching debt burden of 70 per cent of budgetary expenditure. But it is within this scenario that the local stock market has shown exceptional bullishness in the first quarter which in fact maintained a trend that started in 2003. We did a crude analysis of the latest bull run in an effort to assess whether it was different from others on the local market by examining some first quarter trends in the main JSE index over the last ten years: First Quarter Trends in the JSE Main Index (1994-2004). See chart.
Developments on the main local JSE index for first quarter 2004 was beyond all previous first quarter growth for the last 11 years, from 1994 to 2004. While acknowledging that first quarter 2000, 1994 and 2002 were exceptional this year's performance has been particularly heady.
We compared the actual annual growth in the index against annualised first quarter gains each year. What do we find? There was an even split (see 'Winner' column).
Indeed in those years where first quarter results have been strong (as in 2004) it has not held for the entire year. Annualised projections (based on first quarter results) were better for 1994, 1995, 1997, 1999 and marginally so in 2001.
METHODOLOGY OF INVESTMENT
At the same time, where the first quarter has been flat or even negative, the actual annual growth in the index has been better. What all of this points to is that a first quarter bull market in our local market invariably gets corrected usually in the ensuing six months. In that regard a correction was always on the cards for our market this year and the current retreat is not unprecedented. The next stage of our analysis then might be what would be an appropriate methodology of investment into this market now. If you chose to be a 'market timer' you are now simply buying and then selling based on the movement of the market.
On the other hand, the buy-and-hold strategy encourages investing for the long term by buying and then 'holding' rather than selling to match the movement of the market up and down. We hold the view (like some famous and very wealthy gurus including Warren Buffett and our own Michael Lee-Chin) that a stock should be held for a minimum of five years.
What our trends have also shown above, however, is that over the 10-year period (1994-2003) first quarter average annualised index growth is showing a healthy premium over the actual growth in the index. That is one up for the market timers. But the bigger issue is that no one, not even the most experienced market timer can argue with any definitiveness where a bull run will peak. That evens things out a bit for those like ourselves from the buy-and-hold school.
There is always room for some degree of market timing in any portfolio however. There are several approaches here. One approach that we like is advocated by James B. Stewart, editor-at-large of Smart Money (The Wall Street Journal magazine of Personal Finance): Sell at intervals of 25 per cent gains. In other words for those stocks that form a part of your 'timing' portfolio sell as soon as they have made capital gains (growth in the value of the stock) of 25 per cent. It means, naturally, that you are forfeiting further profits as many stocks will rise far higher, upwards even of 200 or 300 per cent as we have seen in the local market in recent years.
So why take profits at 25 per cent? This sometimes produces significantly higher returns than a strict buy-and-hold strategy even acknowledging that it is also generating far lower returns than buying when the market bottoms out and selling at the peak. But no one possesses the clairvoyance to achieve continuous exceptional returns (though many seem to keep trying). It is not realistic to expect to sell only at the absolute peak and buy at the bottom. A minuscule few have done it based largely on luck rather than any analytical approach. The researched probability of this happening in a sustained manner, however, is very low indeed.
In fact recent research (noted Financial gurus Ben Stein and Phil DeMuth) provide strong statistical data to support the argument that total long-term return on stocks is greatly enhanced when market timing is added to a mixed strategy that would also include a Buy and Hold approach. When all is said and done the best time to buy is when stocks as a group is cheap.
Hopeton Morrison is general manager of St. Thomas Co-operative Credit Union Ltd. and lecturer in the School of Business Administration at the University of Technology. Please send comments and questions to: hmorrison@stccu.com
