Excuse me, but do you have a wealth rebuilding strategy?

The Business Times
Published November 15, 2008
Excuse me, but do you have a wealth rebuilding strategy?
A strategy provides the discipline to remain in the market at a time when even the bravest are unnerved

By Sani Hamid
Director, wealth management
(economy & strategy)
Financial Alliance

JUST as it has taken wealth away, the market provides the best opportunity to get it back.

Over the past year we have experienced unprecedented wealth destruction that has set back the financial plans of many investors. But rather than look back on the past and lament on what they should - or should not - have done, investors should look to the future and decide on how to put their financial plans back on track. In other words, they must start rebuilding their wealth.

Markets will recover: Are you prepared?

I don't profess to know where the bottom lies or how long the current slide will last. But I do know that if the Dow Jones Index can recover from its two darkest hours - the massive 1929 crash that led to the Great Depression and the 1937 pre-World War II crash - it will recover from the 2008 slump. The point I want to drive home is that investing isn't about whether markets will bottom and recover - they always do. Investing is about being prepared when recovery happens.

Evidence from previous crashes suggests markets undergo four distinct stages of recovery (see accompanying charts). And as I see it, at each stage investors need to adopt a different strategy to rebuild their wealth. Having a strategy is vital - it is the framework on which investments should be built. A strategy provides the discipline to remain in the market at a time when even the bravest are unnerved. Investors also need to have time and patience on their hands. Otherwise they will be easily cowed by short-term setbacks, afraid the market will again take away what they may have regained.

Stage 1: The base-building process

This is where the market finds its footing and a bottom. It normally - but not necessarily - involves a pattern of three distinct bottoms. The 1929 Great Depression crash, the Pre-World War II crash, the dotcom-cum-9/11 crash and even the declines seen in the Asian crisis all had these base-building periods. In some cases, they look very much like an inverse head-and-shoulders pattern, a major reversal pattern from the technical analysis viewpoint.

The key strategy at this stage is to accumulate. Investors should look to enter the market using dollar cost averaging (DCA), because trying to pick the actual bottom is futile. If investors truly believe that markets will eventually recover, they should not be afraid of further declines, but instead should see DCA as allowing for the accumulation of even more bargains and the lowering of their portfolio's overall average buying price.

Investors should appreciate the fact that right now they will now be buying into grossly oversold markets with a chance they could be left 'holding the baby' at the bottom. I find it ironic that many are uncomfortable buying in, because just 12 months ago they were more than comfortable to buy into a grossly overbought market despite the risk of 'holding the baby' at the top.

The so-called recovery portfolio that one builds at this stage will depend largely on risk appetite. At Financial Alliance, we have structured a 100 per cent equity-weighted recovery portfolio with a heavy focus on Singapore and China to suit investors with moderately aggressive to aggressive risk profiles. For investors with moderate and moderately conservative risk profiles, we would recommend a similar but more diversified portfolio incorporating some exposure to Singapore bonds.

Stage 2: The rally from an oversold position

This stage involves a strong rally as the market recovers from a grossly oversold position. Many times the market prices in the worst-case scenario, only for people to realise when the dust settles that things have been overdone from a valuation standpoint. When confidence does eventually return, it is accompanied by a sudden realisation that the market has grossly overshot to the downside. Ideally, one should already be in the market by that time - with a well-positioned recovery portfolio - to take advantage of the upswing.

Stage 3: The consolidation process

This is where the market likely trades sideways for a while as companies and individuals rebuild their devastated balance sheets. During this period, the focus will be on which stocks will emerge from the oversold stage to enter a new expansion stage - that is, Stage 4. There could be minimal changes to an investor's Stage 1 recovery portfolio, as many of the parameters used to decide the make-up of the Stage 3 portfolio are similar. However, one cannot rule out more drastic portfolio changes in Stage 3 as we come to understand just how severe the second-round effects from the present crisis have had on future economic growth in various countries and on various asset classes. Investors should also look to include alternative investments in their Stage 3 portfolio, given the anticipated sideways performance of the stock market during this period. This should help investors position themselves for Stage 4 - when the market resumes its uptrend.

In summary, we all know that just as how the market has destroyed wealth, it will eventually create new wealth. The road ahead will be a challenging one, but those who prepare themselves well will reap the benefits when recovery inevitably begins.