Are We Due for a Correction?

Lately, it feels like every time I check the markets, both the US and SG stock indices are charting fresh all-time highs, and even my portfolio are hitting new highs daily.  What is more surprising is that this continues to happen even when the economic data, like the latest disappointing employment numbers, does not quite line up with the optimism we are seeing on the screen.  It makes me wonder are we riding too high on hope rather than fundamentals?  Consequently, the biggest question in my mind is, when is the next correction/ market crash that every seasoned investors are talking about, coming?

Currently, markets are being buoyed by one main factor: the expectation that the FED will continue cutting rates, at least 2 more times this year.  Liquidity and cheap money are the oxygen of financial markets, thus every time the FED signals that cuts are on the horizon, investors rush to front-run that move, pushing valuations higher and higher.

However, how long can this “hope trade” last?

If rate cuts do materialize, the narrative is that lower borrowing costs will boost corporate profits and spur economic growth.  On the flip side, rate cuts may also mean that the FED sees trouble brewing.  If employment and growth are already showing cracks, does cheaper money really offset the risks?  Furthermore, with rate cuts now, will inflation numbers spike again with more sudden tariffs imposed in future to various countries or sectors, contributing to stagflation?  I do not have a crystal ball, but I do know that rate cuts do not eliminate risk.  They simply cover one issue with another issue, and at the meantime, hoping the situation does not blow out of control.

Closer to home, the Straits Times Index (STI) has also broken new all-time highs.  For years, the local market has been lagging the world.  Compared to the tech-fueled US indices, Singapore stocks have always been the “steady, boring” type, consisting mainly banks, REITs and telcos.  So at this juncture, is the STI truly overvalued, or is it just playing catch-up?

Looking at the PE ratios, the US markets are undeniably richer, trading well above long-term averages.  Currently the trailing PE ratio of S&P 500 is around 30.2, while the long-term average PE ratio hovers around the low 20s.  The STI, on the other hand, is not in bubble territory yet, as its current trailing PE ratio is around 13.7, while the long-term average PE ratio hovers around 13.  Within STI, banks are still reasonably priced relative to earnings, and REITs, despite recent interest rate cuts, are still way below the euphoric valuations of the past.  It does feel more like a catch-up story than a frothy bubble, though we should not dismiss risks outright.

The Correction Question

As such, could a correction be near?  Corrections are part and parcel of markets, and after such a relentless rally, even a 10 to 20% pullback in the US markets would not be shocking.  When that happens, STI will not be spared either, because correlations tend to spike during downturns.  Money flows are global, and Singapore’s market will definitely feel the tremors.  So when will the correction happen?  Your guess is as good as mine.  

What I Am Thinking And Doing Moving Forward

For me, the takeaway is simple:

1)     Stay invested, but stay grounded.  This is not the time to chase every rally or pile into frothy stocks just because “everyone else is making money”.  I am not good with timing the market, I am unable to buy at the lows and sell at the highs.  The only thing I can do is to remain vested, and continue to collect dividends through the ups and downs.

2)     Diversification matters.  Although both Warren Buffet and Mark Cuban have both declared that "diversification is for idiots", I openly admit that I am no expert in investing, and no amount of conviction I have in any particular stock can enable me to "all-in" 100% into that stock, remain vested and still sleep well at night without a tinge of anxiety.  For peace of mind, I am pleased and contented to embrace diversification.  I continue to anchor my portfolio with dividend plays and REITs, because they provide steady cash flow regardless of market sentiment.

3)     Keep cash reserves.  Not everything needs to be fully invested.  Having dry powder allows me to take advantage when corrections come.  However personally, I am not holding large cash reserves and the cash allocation is only about 1.7% of my portfolio currently.  I hope to slowly increase it to about 5% in the longer term and stabilize around that level.  It seems low, but every quarterly my portfolio generates cash-flow in the form of dividends, which helps to boost liquidity in times of need.  As such in the longer term I believe 5% is a comfortable level for me.

4)     Valuation awareness.  I will not deceive myself, markets are not going up forever and my portfolio value is not going to just increase month after month.  If markets are stretched, I need to adjust my expectations.  Portfolio value fluctuates and I need to be mentally prepared for it to drop by 20%, or even crash by 50%.

At the end of the day, I remind myself that markets move in cycles.  Rate cuts may fuel optimism for a while, but fundamentals will always catch up eventually.  As accomplished and outstanding fellow blogger and dividend investor STE recently posted "Stock Market: The Art and Science of Regression to Mean", over the long haul, markets tend to settle back to a baseline (or so called regression to mean).  For now, I am contented to collect dividends, stay patient, and let the noise play out.  If a correction comes, I will be ready with some cash buffer on hand, not much, but at least I am not fearful.  Barista FIRE, here I come...!