[Practical Finance] First Time Facing a Sharp Drop... "Here's How to Handle It Next Time"

Market Collapse Due to Excessive Supply-Demand Imbalance
Need to Respond by Comparing Past Sharp Decline Cases
Can Estimate Bottom Using PBR, PER, etc.

On the 5th, a 'Black Monday' event caused the market to plunge sharply. This was the largest point drop in history. While the aftershocks of the plunge still have investors shrinking back, the securities industry has warned that although the drop may not reach the scale of 'Black Monday,' market shocks can reoccur at any time. Furthermore, although it is impossible to predict the exact timing of the next sharp decline, experts advise that the best response can be made by utilizing past cases and valuation indicators.

According to the Korea Exchange on the 14th, the KOSPI closed at 2621.50 on the 13th. It has shown significant volatility, rising 7.37% over six trading days. The difference between last month's peak of 2896.43 and the intraday low of 2386.96 on Black Monday is 509.47 points, representing a 17.6% drop. Notably, during Black Monday alone, the largest point drop in history of 234.6 points occurred, driving investors into 'panic selling.'

Before this sharp decline, various narratives surrounding the stock market downturn had already been unfolding. These included uncertainties over the U.S. presidential election and the Trump trade, economic slowdown leading to recession fears, controversies over AI profitability and excessive valuations of big tech, and the unwinding of the yen carry trade, all of which fueled the decline.

The securities industry analyzes that the essence of this plunge lies in the 'resolution of excessive supply-demand imbalances.' Sung-hwan Kim, a researcher at Shinhan Investment Corp., stated, "Over the past two years, investors built long positions in tech stocks and Japanese equities, while shorting the yen and U.S. Treasury bonds," adding, "This supply-demand imbalance excessively deviated from fundamentals, causing a sharp rise in stock prices." He continued, "When the yen strengthened amid overlapping heavy trading, the supply-demand imbalance was simultaneously attacked," concluding, "It was once again confirmed that assets that have risen significantly undergo panic selling."

Response Possible by Comparing Past Cases and Utilizing Valuation

Experts agree that when faced with an unexpected sharp decline, it is better to respond appropriately rather than just stand by. They advise comparing past cases if another market shock occurs. Hae-jung Yang, a researcher at DS Investment & Securities, said, "During the 9/11 terror attacks and the COVID-19 pandemic, rebounds were quick, but during the dot-com bubble burst and the financial crisis, it took about a month to stabilize," adding, "It takes time for measures to be introduced and for their effects to be recognized to mitigate the shock."

Yang expects that some waiting will be necessary to recover from the 'Black Monday' drop. He forecasted, "If it is not a recession, it will take about a month to digest economic indicator releases confirming no recession, the Jackson Hole meeting, and the Federal Open Market Committee (FOMC) sessions."

Additionally, it is analyzed that valuation indicators should be used to gauge the bottom during a sharp decline. Da-woon Jung, a researcher at LS Securities, pointed out, "Empirically, periods when the price-to-book ratio (PBR) falls below 0.9 times are short-lived opportunity zones." In fact, since 2018, after the KOSPI's PBR dropped below 0.9 times, the average time taken to rebound above 0.9 times was 23 days. Notably, 16 out of 25 cases recovered within 10 days, and 9 cases rebounded within a single day.

If the PBR is near its low, the price-to-earnings ratio (PER) can be additionally checked. Since 2006, the KOSPI's 12-month forward PER of 7 to 8 times has acted as a resistance level. However, Jaehwan Heo, a researcher at Eugene Investment & Securities, advised, "PER is affected when confidence in earnings weakens due to recession concerns," adding, "In phases of shaken sentiment, its support significance may be limited."

Domestic Market May Be Relatively Strong After Initial Decline

Meanwhile, there is a forecast that once the initial downtrend in this decline settles, the domestic market may perform better compared to the U.S. market. Hyun-ki Kang, head of equity strategy at DB Financial Investment, said, "After the initial market decline, the Korean market's relative performance could be stronger than that of the U.S.," noting, "Looking at the dot-com bubble burst, both the U.S. and Korean markets experienced sharp initial declines, but then diverged."

In fact, after the sharp drop in 2000, while the U.S. market continued a major downtrend, the KOSPI entered a sideways trend and formed a trading range after the initial decline.

Kang explained, "This relatively better performance of the KOSPI is related to the characteristics of leading stocks," adding, "Leading stocks rise the most when the index goes up but fall the most when the index declines. During the dot-com bubble burst, the U.S. market, the origin of leading stocks, experienced the sharpest decline, while the KOSPI's drop was less severe." He added, "This logic will apply this time as well."