Saturday, June 16, 2012

Are Stocks Under Performing the Index? Case Study - Indonesia

There is always a belief that by holding Defensive Stocks or Blue Chips will enable you to weather the storm during a Financial Crisis. What we will do now is to build a case on whether holding on to stocks will outperform the Market Index. To do this we will use the Global Financial Crisis in 2008 as a backdrop in our study. We will be using the Jakarta Stock Exchange as a Case Study our study will be based on the following assumptions.


  1. Period of comparison is from the 2007 High to Current value.
  2. Stocks in study will be the 10 largest listed companies in the JSX as of 2010
  3. Stock  split and bonus are taken into account


Our mission will be to compute the performance of the top 10 index linked companies in the Jakarta Stock Exchange. As indicated by Index linked stocks, we mean that the performance of those stocks in question will be closely linked to the movement of the Jakarta Composite Index.



How do we compute the Index performance?


What we will do is to get the high of the JCI during 2007 which was set on 12th December 2007 which is 2818 points and the current (15/06/2012) level of the Index which is at 3818 points. The reason for using the High of 2007 is because we want to find out how much the current Index level had improved since then. Below is the monthly chart for the Jakarta Composite Index. To compute the performance of the Index we will use the following formula.





(Current Level-Previous Level/Previous level) x 100

Which will lead us to the following.  (3818-2818/2818) x 100 = 35.5%

That means that the Jakarta Composite Index have recovered from the high of 2007 and managed to outperformed it by 35.5%. So obviously when we want to measure the performance of individual stocks, it must outperform the index by at least 35.5% since we are using index linked stocks where their performance is ‘closely hugged’ to the movement of the Index. That means if there is a 5% gain in the index for a given year, the index linked Stocks should be up by at least 5%  if they are to outperform the index.


Table for Stock Performance from 2007 – 2012


Top 10 largest listed Companies in Indonesia as of 2010
               AB = A x 35.5%              CD= (B-C)/B x 100Return on the
RankingCompany1997 High1997 High x 135.5%Current PricePerformance  %1000 Rp Invested
1
Telekom Indonesia
12800
17280
7900
-54
460
2
Bank Central Asia
3175
4286
7100
65
1650
3
Bank Mandiri
4050
5467
7000
28
1280
4
Bank Rakyat Indonesia
4350
5894
5950
1
10
5
Bank Negara Indonesia
2858
3872
3725
-9
910
6
Bumi Resources
8750
11812
1080
-91
90
7
Bank Danamon
5554
7497
5850
-22
780
8
Perusahan Gas Negara
3400
4590
3400
-26
740
9
Semen Gresik
6250
8468
11100
31
1310
10
Bukit Asam
12800
17289
13350
-22
780
Net Return Performance
8090




          



Index Linked Stocks Under-Performed the Index


As you can see from the above Table, if you have invested Rp1000 on the above 10 counters during Dec 2007, the return you will get on 15/06/2012 is – 19.1%. Your total investment of Rp10000 will only yield Rp8090 which is a loss of Rp1910. So what we can conclude is that even though the index went up by 35.5% but the index linked stocks still UNDER-PERFORMED the INDEX throughout that period.


Compare to other Investments?


So how about other alternative investments? One of the best comparisons will be the Money Market fund. By Money Market we mean funds that are park at Stock Market accounts in Broking Firms. Indonesian money market pays pretty well and it can be in the vicinity of 9-10%. Ciptadana Sekuritas used to pay about 9% per annum for their Money Market account until the Indonesian Government stop Broking firms from accepting deposits recently.


Again using our same Rp10000 as the base investment so how much better would it compared to stock market investment from the time period in 2007 till 2012? To calculate the future returns on the present value of RP10000 we will use the following formula.


FV = PV(1+i)t  where

FV = Future Value
PV = Present Value
I     = Interest rate – 9%
T     = time period – 5 in this case


So the FV = 10000(1+0.09)5 = Rp15386.24


Hence, we can deduce that during that period of analysis in Indonesia, the Money Market return (Rp15386.24) is better than the Stock Market return (Rp8090).


Why is this so?

The following offers some explanation on why Stocks tends to Under perform the Market Index.

Firstly, new stocks are added every year through IPO. At the meantime old stocks that are not performing or went into bankruptcy are delisted from the exchange. There are more new stocks added to the list than being taken out and hence the list of stocks grows every year. The Darwinian Law on survival of the fittest also applies to the stock market. Hence every year bad and poorly performed stocks are taken out of the list and new and healthy ones are added to the list.


If you look back at the records of Dow Jones for the last 100 years, less than 3% of the stocks managed to maintain their original name. For the past 50 years only less than 10% managed to do that. What does this tells us? A lot of the companies did not survive intact throughout the years, many of them either delisted, gone during a Merger, Acquisition or being Takeover exercise. And again along the way many new stocks are added while old ones are pushed out from the list.

This is one of the main reason why the stock market is always going up.

Secondly, the Composite Index is made up of only a handful of Stocks. Like the Dow is made up of 30 stocks, Malaysia's KLCI has 30 and so on. Normally these stocks have large market capitalization and hence also their weightage on the Index. Again it is the same old story, ‘not performing or tired’ stocks are taken out of the group and new ones are added into it. So this can be regarded as cheating and they can do continue doing this as long as the index keep going up.

This is also similar to Hedge Funds when they apply survivorship bias in their reporting. Since they are not under the jurisdiction of the Securities Exchange they are not required to report to them. In other words, they are free to cook their books. Under perform quarterly figures are discarded from their annual reporting and hence their reporting is always better than their actual performance.

So why do they want the market to go up? In my earlier article I mentioned that an overvalued market benefit everyone from the stock brokers to the politicians. Only us suckers got squeezed in the end because when the music stops, we are the ones will be the last to leave the party.

Thirdly, we only have ourselves to be blamed. Due to the propaganda by the market promoters and propagandist from the corporate mainstream media we are more or less afflicted with a disease called ‘Normalcy Bias’.

Normalcy Bias refers to a situation where the mental state of the people failed to estimate the possibility and effects of a disaster that is looming. When facing a stock market crash instead of taking evasive action to cut loss we tend to focus on the unexpected event and enter into a state of paralysis. It is normal for investors to be overwhelmed by losses and hence failed to do the right thing and that is to get out of the market. This is because we are constantly fed with ‘good and soothing’ stories by the mainstream media and condition our mind to accept that things are always in good hands and order. Consider the following quote,

"The man who never looks into a newspaper is better informed than he who reads them; in as much as he who knows nothing is nearer to the truth than he whose mind is filled with falsehoods and errors." – Thomas Jefferson


Where is the Problem?

The main problem is OURSELF. Why? Because we did not bother to TIME the market because we always believed that the market will always deliver and hence let nature takes its course. In other words we didn’t sell when the market says SELL and we just hang on with the Investments. When the next Downturn comes around, you will find that not only your gains will be wipe out but worse still it will result in a negative return on your capital as shown by our example above. So we must learn to TIME the market. Sell when you need to and buy back later at an appropriate price.

As for an illustration we shall take Telekom Indonesia as an example. The following is the weekly chart for the Telekom Indonesia from the period 2007 – 2012.





I have already  marked the BUY signal using the Green circles and SELL signals using the RED circles. As you can see from the chart there are three different opportunities for you to greatly increase your return by selling when the price goes above the 70% line in the RSI and buy when it goes below the 30% line in the RSI.



This represents only one of the simpler method you can trade the market, however as you go along you will find that you need much more complex tools to study the market more professionally. Eventually you will need to understand support and resistance, rebounds and declines percentages, pivot points, market turning indicators, time series and many more if you want to improve your trading techniques.

Trading in markets is never an easy task as many perceived, you need to put in a lot of effort and you need sweat blood over your analysis. It is not like launching a ‘fire and forget’ Exocet missile because in financial markets there is nothing such as ‘buy and forget’ kind of strategy. You will need to manage, monitor and also rebalances your portfolio every now and then.

As for myself, I am monitoring over 17 Global Stock Exchanges and 2 Futures Exchanges and spend many hours in reading apart from writing more than 20 articles a month. This is because due to the nature of financial markets which is affected by tens if not hundreds of variable and ‘Change is the only Constant’, we need to constantly update ourselves. This is also due to the fact that financial markets today are more closely linked to world events than before. A drop of 500 points in the Dow overnight will surely affects Asian Markets when they open the next morning and similarly a huge drop in corn prices in the Futures Market will surely affect American corn farmers in the days and weeks ahead.


Currently we had started using Spectral Analysis where its approach to the market is similar to Fourier Transform. Geologists have long been using Spectral Analysis to analyse data from their oil drilling operations with great accuracy. Fourier Transform is also being used to analyze vibrations in aircraft wings by studying the pattern of its Sine wave.



Both of them can be used to study the Stock Market's Sine Wave movement to determine actual entry and exit points. The advantage of using Spectral Analysis in analyzing Financial Markets is that it needs less data to achieve better accuracy and results. So that means we can use Spectral Analysis for stocks that have less than 3 years of historical data.  


It is known that movements in most Financial Markets mimics the Sine Wave with peaks and valley quite evenly distributed. So our next objective is to use the correct tools to help us identify the ‘Soft Spots’ in these peaks and valley that will greatly improve our timing in the entry and exit points. Identifying these soft spots is akin to Tennis Players trying to hit the ball on the soft spots (located at the center of the racket) in their racquets. These peaks and valley are our soft spots for entry and exit points in the markets. It can be shown by the following.


Eventually the ultimate aim for any Stock Market Trader is to reach a Trading Mastery level where we call it the ‘ZEN of TRADING’. When you had reached such a level you are able to approach the Stock Market with a peaceful and tranquil mental state. You are able to predict Financial Market movements with great accuracy.


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