Singapore-based financial blog that aims to educate people on personal finance, investments, retirement and their Central Provident Fund (CPF) matters.

Wednesday, 1 October 2014

Correction Overdue Follow-Up

05:31 No comments

I received some feedback from people who read my previous post (A Correction Overdue).
One of it was that the chart presented in the post was not enough an evident to prove that correction is not on its way.
Secondly was that the economy is growing at around 2%-4% while the stock market has advanced 7% excluding dividends, stock market grew 2times the economy, which means it is ahead of economy by 2 times.

Firstly, thank you for the feedback. All feedback are welcome and I certainly hope that there will be more to come!

1) So first, I wish to show more evidence that a correction will not occur anytime soon and it is based on the charts. Fundamentally I have proven that a correction will not occur because the stock market is not running ahead of the economy.
Below is the chart that I showed on my previous post on the market:

Below is the chart that shows the last correction in 2010:

A correction occurs when the stock market has charged forward faster than the economy is growing. Based on the above 2010 chart, between the period of February to May (less than 3months), the market went up by nearly 14%. Technically, the economy did not growth that much during the same period, which I guess led to the sell-off near end of April.

Historically, any short-term big rise are often followed by a correction. 'Short-term' meaning within a quarter and 'big rise' usually more than 10%.

Another chart below is from the 1999 correction where the market went up by 14% between June to August (less than 3months) and that was followed by a correction that led to the market dropping back to June's levels.

I believe a lot of the above examples can be found as we research through the history of corrections. Up till now, the market is moving cautiously, where there has not been a more than 10% gain within a period of 3 months. So fundamentally (economy) and technically (charts), a correction is very unlikely to happen within the next several months.

2) The economy is growing at a rate lower than the stock market, this must mean a correction is coming soon right? Well, actually no. The stock market is actually leading ahead of the GDP instead of GDP leading the stock market. GDP data however, is used to create a correction in situations where the stock market grow more than the economy did.

The stock market performance one way or another, is a projection of future growth. GDP data however, is a reflection of past growth. So even though the GDP did not showed good results, the market can still perform well if the market thinks that the future GDP growth will be better.

GDP data is also not reflective of stock market performance because of a lot other factors.
i) Buybacks - this reduce stock supply which leads to higher prices
ii) GDP measures a country's consumption, export and investment. However, it does not measure profits, which is the key determinant of valuating the stock market.
iii) GDP measures domestic progress. However, many companies listed on the US stock exchanges are global companies with global revenues not shown on GDP data. Apple selling an iPhone in China is counted as GDP in China but not in the US.

I hope this clarifies a lot of the queries. Please do comment on any more doubts and I will try my best to answer them!
Thank you!
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