Thursday, July 23, 2009

Tea Leaf Fundamentals

I just read a blog post from a guy who presents himself as a friend to technical analysts but when we are not looking he throws out zinger after zinger in his missives. To wit:

Plenty dismiss the notion of chart watchers divining the future direction of stocks from patterns, but as market blogger "Mr Hyde" (to protect the two-faced) noted in a recent post, there can be value in paying attention to chartist chatter. ”The only justification that I see for paying any attention to chart patterns is the simple fact that many others pay attention to chart patterns, which then moves chart pattern analyses to the behavioral science realm – the study of your fellow investment rats and how they run the maze,” he wrote.

Hmm, let's turn that around.

"The only reason to pay attention to earnings and market share is the simple fact that many others pay attention to chart patterns, which then moves chart pattern analyses to the behavioral science realm – the study of your fellow investment rats and how they run the maze."

But don't higher earnings translate into higher market price for stocks? Yeah, that worked over the past 10 years, didn't it? And how do you explain why any stock trades above or below fair value, whatever that is?

The simple fact is that stocks deviate from fair value because investors, and I use that term lightly, think they are worth more or less than that. The fundamentals do not and cannot explain how a stock is priced in the marketplace - period. Go ahead, prove me wrong.

Therefore, higher earnings are like cheese to the rats, as Mr Hyde would say, just like chart pattern breakouts would be the same for technicians.

It is not patterns or earnings that give stocks their prices. It is supply and demand for shares because no matter how great earnings may be, if nobody wants the stock then it will not go up in price.

Rant over. We now return you to your regularly scheduled program.


rb531 said...

Nasdaq Check: We are close to that 2020 where both fibonacci 50 retracement and long term downtrend will collide. Should make a good case for a pullback? What if it pierces that one and stay above? Another super rally? man..Hope my kid will get to see that pullback.

paulocuana said...

Nice rant. I agree completely. Can we go one step further and say that it all boils down to psychology with technical analysis representing the common vagaries of human emotion?

Here's what's keeping me up late (besides too much caffeine at lunch): Junk Bonds.
If you look at the FINRA-Bloomberg Index, or the Merrill Lynch US High Yield II Index, junk bonds are back to the level of a year ago.
This seems incredible to me. It's like Lehman never happened.
Can it be that the perceived risk of default is the same as a year ago? What are these people smoking?

Paul O'Cuana

William said...

Whenever someone gives you a "fundamental" argument, all you need to say is, "show me your model." Send my your excel file and I'll take a look at it. Otherwise shut up. As an individual, fundamental analysis isn't efficient to be investable since you can't model the whole S&P. So when someone makes a fundamental argument they are most likely just repeating some others work or just making up an opinion.

People feel comforted with fundamentals because you have hard numbers like "earnings". But believe me, if you've been part a a research team, you know that you make up half your numbers. When modeling you make up just about everything. Inflation expectation, interest rate to discount earnings, future earnings... to get to an intrinsic value figure, YOU MAKE UP 90% of the model's numbers.

The only fundamental analysis that's efficient enough for an individual non genius to do is to look at most recent earnings into perpetuity, if a stock is trading at more than a 50% discount than you might have something intrinsic-value-wise. Even still, that not nearly perfect. Most stocks fit that bill right before the last year's October crash. Would you have had the Buffet like fortitude to hold through that? TA told you that the tape was about to get ugly.

Bottom line: if someone hasn't been up past 3 am, going on for over 20 hours strait, modeling cash flow, and has to report to corporate, they are a neophyte at real fundamental analysis. Believing their opinion has value is, well, stupid.

paulocuana said...


I can tell you that it's no less silly on the corporate side. Earnings expectations are always met preferably by a penny or so.
Now where should that reserve come from?

Paul O'Cuana

Amalan said...

my 2 cents...

I think both methods have advantages and disadvantages. Fundamental analysis is not just about earnings predictions - from on going employment/unemployment trends to inventory levels, from interest rates to capacity utlization, there are many factors that paint a current picture, which when interpreted correctly, can give you an idea of where things are headed. Of course, there is no guarantee that the stock market will follow fundamentals, but it doesn't completely ignore it either.

Eventually, for both FA and TA, it boils down to collection of data and the interpretation of them. Most of the time, one or the other is flawed.

I personally think sentiment analysis could be very valuable, except I am not sure we are getting the right kind of data. With so many sources of information out there, can we really believe that one group or the other has a better pulse on a consensus view? Money managers can be polled, but then so can CEOs and individual investors - will the results of all align? And even more difficult to fathom is if any of them are actually acting on what they are saying! Feeling optimistic is one thing, but if you aren't buying, our interpretation of bullish sentiment is now flawed. Money managers could be very bearish, but their followers might already be in the market without any intention of increasing their holdings.

I'll never forget Buffet pointing out how GDP can grow very well for something like 15 years and still not be accompanied by stock market performance, and then another 15 years of great stock market performance can be accompanied by very low GDP growth...this is a reflection of major shifts in sentiment, not correlated to fundamentals.

Quick Takes Pro said...

"The biggest mistake fundamental analysts make is thinking that a company and a stock are the same thing.

The biggest mistake technical analysts make is thinking that they are different."

- Phil Roth, Chief Market Technican, Miller Tabak

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