At my many Mad Hedge Fund Trader Global Strategy Luncheons, speaking engagements and conferences which I attend around the world, I never fail to get asked the same question by beginning traders.
“Which is more useful, fundamental or technical analysis?”
That question has earned a heightened urgency over the past few weeks, when I have had two diametrically opposed groups of analysts screaming in my ears.
Fundamental researchers are asserting that S&P 500 earnings will hit $130 per share in 2016, giving us a forward PE multiple of only 15, dead in the middle of an historic 10-22 range.
That is a number that Goldilocks would love, not too hot and not too cold. It makes stocks fairly valued and nowhere near a bubble top.
The dividend yield on equities is now well over 2% and rising, far in excess of a 10-year Treasury bond yield that is 2.00% and falling. Company share buy backs are about to resume in February. We have only just begun an historic period of seasonal strength.
Since there is nothing else in which I can invest with a reasonable return, I should be loading the boat with shares during the current transitory dip.
“BUY!”
No, no, cry the technicians, wringing their hands.
The S&P 500 has just broken a major trend line that has held up for the past six years. Consumer staples are outperforming consumer discretionaries, the 50-day and 200-day moving average lie shattered.
Adding fat to the fire has been the spectacular outperformance of bonds over stocks, another clear “RISK OFF” indicator.
“SELL!”
What is a befuddled individual investor to make of all this?
The answer I always give my confused, befuddled and disoriented questioners is this: “Use fundamentals for your long term allocation calls, and technicals for your short term execution.”
My belief is that fundamentals always win out over the long term, and that technical cues are at best, a lagging indicator. I use technicals for guidelines on where to place orders on a short-term basis. The longer you stretch out your time frame, the less relevant they become.
At best, technicals are right 50% of the time, right in the same league as a coin toss, most stockbrokers and my bookie. The same technicians making the incredibly bearish prognostications today were offering equally convincing bullish arguments in December.
How many pure, dedicated, technical analysis only driven hedge funds are out there? None! All hedge funds are fundamentally driven. If technical analysis really made money on its own, there would be thousands of them by now.
You can get 90% of the basics of technical analysis just from buying a used book on Amazon for $5. This is why you find so many young traders relying heavily on technical analysis. It is a cheap and easy entry ticket to the game.
As for fundamental analysis, you never know it all, the number of variables is so vast and changing daily. I suppose this is why I like it so much. I love the challenge.
Today, in 2016, there is a further complication for technical traders. High frequency traders have also bought that $5 book from Amazon and written algorithms that do exactly the opposite of what these books recommend.
That’s because they know that volume increases at key technical and support levels on the charts, increasing the number of times they can collect their 0.1 cent tolls. This has led to a huge increase in the number of false breakouts and breakdowns on the charts in recent years, frustrating technical traders and individual investors to no end.
Technical analysis appeals for a good reason, and not just because it is cheap and easy. Since we are descended from prehistoric hunter-gatherers who roamed the African savannas a million years ago, we are all visually oriented mammals. We have incisor teeth, forward facing eyes, and strong sprinting quadriceps.
In other words, we are all predators, except for my yoga instructor.
We therefore respond to stimuli we can see much more rapidly than those we can conceive in our minds. A picture truly is worth 1,000 words, and probably a lot more, possibly an entire book.
That’s why so many brokerage firms and financial advisors use pictures, or charts, to sell research. They are so easy to understand.
After 47 years in the business (and 50 if you include the shares I bought when I was a paperboy), I’ll tell you what I notice when I listen to those with ten or twenty years more experience than I. And at this point, there are only a tiny handful of them.
The best fundamental analysts talk like technicians, while stellar technicians speak like fundamentalists.
I can’t tell you how many times I heard a top performing active manager mention buying at a key support level, whereas the technician lets drop that the PE multiple is only 9. They are endlessly using others' arguments to bolster their cases.
Key support levels are excuses for fundamentalists to find the file on that long unloved sector they lost behind the radiator. Technicians will often narrow their search for more interesting charts by starting with lists of low PE stocks.
The takeaway here is that the best of breed are always using every tool in the box. You must to gain an advantage over this ever-gnarly market.
So, over the vast expanse of time, the fundamentals always eventually win out.
Exactly when will that happen?
Don’t ask me. Go ask a technician.
Great Technician, Lousy Fundamentalist
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