The Revenge of the Chart Watchers
Comment of the Day

December 19 2018

Commentary by Eoin Treacy

The Revenge of the Chart Watchers

This article by Richard Teitelbaum for Institutional Investor may be of interest to subscribers. Here is a section:

What prompts investors to chuck Graham and Dodd for a bucket of sheep entrails? More than a couple of factors, including the proliferation of easy-to-use charting functions on Thomson Reuters and Bloomberg terminals, Yahoo Finance, and Google charts.

Most obvious is the burgeoning success of passive investing. In 2007 index funds accounted for 15 percent of ETF and mutual fund assets, according to the Investment Company Institute. In 2017 that number was 35 percent.  

As recently as last year, fewer than one in ten active large-capitalization U.S. stock managers had beaten the S&P 500 during the previous 15 years. 

Accordingly, active money managers today are on a somewhat desperate quest for new ideas, trading strategies, or tactics — anything to narrow the gap between their own performance and that of the big indexers. It is, after all, a struggle for their own survival. 

“Wall Street is neither fundamental nor technical,” say MIT’s Lo. “They are opportunistic.”

Indeed, the problems bedeviling fundamental research feed into the rising popularity of technical analysis. “One reason people gravitate toward technical is they get frustrated with fundamentals,” says Stovall. “Price is never readjusted. Earnings are often readjusted. GDPs are often readjusted.”

Eoin Treacy's view

Part of being a chartist is being contrarian. The reason price action appeals to many of us is precisely because it is not well understood by the masses. Therefore, when I read articles like this, extolling the benefits of technical analysis and trend following, I can’t help but feel cautious rather than vindicated.

Hard fundamental analysts have long distained looking at price because it says nothing about value. What the most level-headed people realise is that fundamental analysis is best for telling investors what to buy while price action tells us when to buy and indeed sell.

Arguably the time when people become most interested in technical analysis is when fundamentals stop working. The GMO report I posted yesterday highlighted the fact the number of companies trading on a price to sales of more than 10 times is a record high. That’s way beyond what a fundamental analyst could justify even with the most optimistic dividend discount model and bloated earnings forecast. Therefore, the only way people can explain the price action is by adopting a trend following methodology. This is tantamount to acknowledging earnings don’t matter.

That conclusion is emblematic of the third psychological perception stage of a bull market because we know earnings do matter. It is that contradiction that readily identifies the psychology of the market as a mania.

It is ironic that fundamental analysts are becoming interested in trends at exactly the same time that medium-term trends have lost consistency and are increasingly looking toppy.

The one group that have been deploying technical analysis and trend following for the last decade are algorithmic trading systems. High volatility means they have to reduce long positions and downtrends mean they should be net short.

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