The above line was derived from the famous quote by John D. Rockefeller (or some say Nathan M. Rothschild) which goes “The way to make money is to buy when blood is running in the streets”.
The colour of blood is red, which is also the same colour to denote a down market or securities price. The phrase “blood is running in the streets” could metaphorically mean the entire market is red, and/or a lot of investors/traders had “bled” their capital, incurring huge losses.
It is at this time when market panic sets in and equities are at a depressed price, oversold by investors to move their capital to other asset classes and safe havens. It is also at this time that bargains can be sought. Being in the same asset class, majority of equities will suffer the “drag-down” effect, including those that are fundamentally sound. This covers the “the way to make money” part of the quote.
The recent equity market decline has sparked several indications of a bear market looming. The United States (U.S.) Standard & Poor’s 500 (S&P500) index had fallen about 12.8% year-to-date (YTD, i.e. from 2 Jan to 24 Dec 2018)1, and the U.S. Dow Jones Industrial Average (DJIA) declined 12.2% YTD2. On the homefront, the Straits Times Index (STI) had dropped 11.1% YTD3. And at the time of writing this, the Japanese Nikkei 225 index had fell 5% intra-day. Quite dramatic falls, I would say, but does this warrant a blood on the streets scenario?
We shall take a look using two groups of indicators: the market Price-to-Earnings (P/E) and Price-to-Book (P/B) ratios, and the Chicago Board Options Exchange (CBOE) Volatility Index (VIX).
P/E & P/B Ratios
Let us take a look at the current P/E and P/B ratios of the S&P500, DJIA and STI:
Fig. 1 – P/E and P/B ratios for the S&P500, DJIA and STI (source: Bloomberg as at 25 Dec 2018)
P/E ratio wise, if based on the conventional number 15, we can infer that the markets are relatively cheap. For the S&P500 and DJIA, with technology and healthcare equities (typically high P/E sectors) taking up 35% and 28% of the indices respectively4, it can be said that they are at a bargain now. On the P/B front, however, the S&P500 and DJIA are still overvalued by conservative estimates, while for the STI on a whole is close to 1.
The VIX, or sometimes called “The Fear Index”, is an indicator used by many investors/traders to gauge market volatility. A high VIX signifies high volatility (and of course, the accompanying fear). It is mathematically calculated with a combination of call and put options on the S&P500 component equities, and I shall not delve further into this (for more information, you could read the white paper from the Reference links below).
The VIX had spiked recently, from 21.63 to 36.07 between 10 Dec and 24 Dec 2018, a 66.8% rise5. There were spikes in VIX’s history, including the GFC period in 2008, the Eurozone crisis in 2011 and the recent one back in February of this year due to a flash crash.
Most of the spikes do not last long; the longest spike was during the GFC and it lasted from Aug 2008 to about June 2009. Many people have different VIX thresholds to signal a buy call, like 25, 30, 35 or even 40.
The Bedokian’s Take
The P/E, P/B and VIX are just a few indicators that can be used to determine if there is really a massive bloodletting out there, though it can get very subjective. There are other parameters to look out for: geopolitical situations, interest rates, regional/sector performance, and of course other asset classes such as bonds, REITs, commodities and cash.
One way to determine buy-in is to use the “10-30 Rule” which I had highlighted in my ebook6 to gauge an entry point/price for an index ETF or equities. Another way is to see if an index and/or share price had gone to its 52-week, 2-year or X-year low, though I would caution this method and I recommend an extensive fundamental analysis to be done along together. Lastly, do adhere to the principles and guidelines for a diversified Bedokian Portfolio (or any of your preferred portfolio allocation) while doing all these.
Brace yourselves and get ready for the storm.
1 – Yahoo Finance. S&P500. https://finance.yahoo.com/quote/%5EGSPC/ (accessed 25 Dec 2018)
2 – Yahoo Finance. Dow Jones Industrial Average. https://finance.yahoo.com/quote/%5EDJI/ (accessed 25 Dec 2018)
3 – Yahoo Finance. Straits Times Index. https://finance.yahoo.com/quote/%5ESTI/ (accessed 25 Dec 2018)
4 – S&P Dow Jones Indices. https://us.spindices.com (accessed 25 Dec 2018)
5 – Yahoo Finance. CBOE Volatility Index. https://finance.yahoo.com/quote/%5EVIX/ (accessed 25 Dec 2018)
6 – The Bedokian Portfolio, p119-120
CBOE. The VIX White Paper. http://www.cboe.com/products/vix-index-volatility/vix-options-and-futures/vix-index/the-vix-index-calculation