Technical Analysis
I saw this article over at The Big Picture yesterday. Since our studies of money flows is a field of technical analysis, I've decided to excerpt this for the blog. It is a part of a longer investment letter. I've only posted the part pertaining to technical analysis. You can read the whole article at the link published at the bottom of this post. {Highlights are mine.}
HOW TECHNICAL ANALYSIS CAN IMPROVE FUNDAMENTAL ANALYSIS
.....Something each group of economists and strategists have in common is the omission of technical analysis as part of their analysis. It is a critical omission, and accounts for why each group missed either the significant turning points in October 2007, or March 2009.
Most of the economists who saw the housing crisis coming turned negative on the economy and stock market in 2006. Although housing was clearly rolling over, technical indicators of the stock market’s health uniformly showed that the up trend in the stock market was intact. Throughout 2006, the advance/decline line continued to make higher highs after every decline. As I noted numerous times throughout 2006, there was a very supportive supply/demand dynamic at work. Companies were buying enormous quantities of their own stock and private equity firms were using cheap credit to take over a record number of firms. In total, almost 5% of the supply of existing shares was absorbed thru buybacks and takeovers. This underlying demand was not met with much selling since the economy was in good shape. Had those crisis prescient economists incorporated technical analysis into their fundamental analysis, they would have remained more constructive on the stock market, without compromising their excellent fundamental work.
There were numerous warning flags in the second half of 2007 and first half of 2008 of the impending crisis that the majority of economists failed to see.......The most significant warning flag was not understanding that the Federal Reserve was going to be far more limited in dealing with this crisis. As I wrote in my December 2007 letter, the amount of credit supplied to the economy from the banking system had shrunk from 75% twenty-five years ago to just 35%. In its place, the securitization markets had developed, but these markets were outside of the Fed’s reach. The Federal Reserve’s capability to manage the credit creation process had diminished, and with it the ability to contain the credit crisis. The astonishing aspect is that even after Bear Stearns collapsed in March 2008, most economists still did not comprehend how far behind the curve the Fed was.....
....Had these economists incorporated a measure of technical analysis into their fundamental views, they would have seen how technically weak the market was as it was making new all time highs in October 2007. The advance/decline line was noticeably lower than in July 2007. They would have also seen how the market broke down in January 2008, which suggested their sanguine view of the economy was on shaky ground.
As the stock market was plunging to new lows in early March, every measure of market momentum was not nearly as oversold as they were in November. This suggested that selling pressure was lessening. In addition, the economic stats had gotten so bad; they had to get less bad given all the fiscal and monetary stimulus.....
Total volume (21 day ave.) has contracted from 1.8 billion shares a day to 1.2 billion shares, since the stock market rally began in March. This is unusual since volume has historically increased in a new bull market. But the stock market is a bit like the line of scrimmage in football. Whichever teams controls the line of scrimmage, usually wins (turnovers aside). In the stock market, the line of scrimmage is formed by the balance between buying pressure and selling pressure. It must be noted that buying pressure almost always holds the stronger hand, since the investment game is skewed by the buy and hold philosophy. Investors are counseled to diversify and buy and hold, through good times and bad times. Large institutions consider cash a performance burden, so they must be motivated by adversity to increase cash. As psychology shifted last spring from fearing bad news to expecting less bad news, selling pressure dried up. It takes only a small amount of buying to push stock prices up when selling pressure is low. Buying has been further reinforced by short covering. During July’s rally, short interest in Nasdaq stocks fell by 5.1%, and 10.3% on the NYSE.
As forecast since March, GDP will be positive in the fourth quarter, and maybe in the third quarter, if inventory restocking kicks into gear. That now appears likely, as the success of the cash for clunkers program will boost auto production in the third quarter. As discussed last month, the National Bureau of Economic Research could determine that the trough of this recession was reached in July or August. Although they won’t make their call until next year, they determined the last two recessions ended in the month preceding an increase in Industrial Production, which did tick up in July. The more important point is not when NBER says the recession ended using a rear view mirror, but that coming economic data points are going to continue to show improvement. As it has, the stream of less bad stats will keep selling pressure low. Even if the double dip economists are eventually proven right, in the short term, the rally in the stock market can continue, as selling pressure remains muted, and buyers control the line of scrimmage.
Since we won’t know for a number of months whether a self sustainable recovery is at hand, or a double dip, combining technical analysis with fundamental analysis could prove valuable, as it did in October 2007 and March 2009. At some point, the stock market and economy will come to an inflection point, and the economy will have to deliver on the expectations for a recovery. As long as the advance/decline line and other measures of market momentum remain strong, corrections will likely be confined to a range of 4% to 7%. However, if breadth falters, the key will be how much selling pressure increases in response to disappointment. As long as selling pressure recedes quickly, and the advance/decline line rebounds to new highs, as it did in 2006 and the first half of 2007, the V-shaped recovery story will have legs. This is what has occurred after each short term high in the market since early May. If a selling squall is followed by a weak rally, the odds of a self sustaining recovery will diminish.......
....I am surprised that so few economists and strategists incorporate technical analysis with their fundamental work, since it can provide additional validation and understanding of when the stock market will take heed of coming economic turning points.
Link: http://www.ritholtz.com/blog/2009/09/how-technical-analysis-can-improve-fundamental-analysis/
HOW TECHNICAL ANALYSIS CAN IMPROVE FUNDAMENTAL ANALYSIS
.....Something each group of economists and strategists have in common is the omission of technical analysis as part of their analysis. It is a critical omission, and accounts for why each group missed either the significant turning points in October 2007, or March 2009.
Most of the economists who saw the housing crisis coming turned negative on the economy and stock market in 2006. Although housing was clearly rolling over, technical indicators of the stock market’s health uniformly showed that the up trend in the stock market was intact. Throughout 2006, the advance/decline line continued to make higher highs after every decline. As I noted numerous times throughout 2006, there was a very supportive supply/demand dynamic at work. Companies were buying enormous quantities of their own stock and private equity firms were using cheap credit to take over a record number of firms. In total, almost 5% of the supply of existing shares was absorbed thru buybacks and takeovers. This underlying demand was not met with much selling since the economy was in good shape. Had those crisis prescient economists incorporated technical analysis into their fundamental analysis, they would have remained more constructive on the stock market, without compromising their excellent fundamental work.
There were numerous warning flags in the second half of 2007 and first half of 2008 of the impending crisis that the majority of economists failed to see.......The most significant warning flag was not understanding that the Federal Reserve was going to be far more limited in dealing with this crisis. As I wrote in my December 2007 letter, the amount of credit supplied to the economy from the banking system had shrunk from 75% twenty-five years ago to just 35%. In its place, the securitization markets had developed, but these markets were outside of the Fed’s reach. The Federal Reserve’s capability to manage the credit creation process had diminished, and with it the ability to contain the credit crisis. The astonishing aspect is that even after Bear Stearns collapsed in March 2008, most economists still did not comprehend how far behind the curve the Fed was.....
....Had these economists incorporated a measure of technical analysis into their fundamental views, they would have seen how technically weak the market was as it was making new all time highs in October 2007. The advance/decline line was noticeably lower than in July 2007. They would have also seen how the market broke down in January 2008, which suggested their sanguine view of the economy was on shaky ground.
As the stock market was plunging to new lows in early March, every measure of market momentum was not nearly as oversold as they were in November. This suggested that selling pressure was lessening. In addition, the economic stats had gotten so bad; they had to get less bad given all the fiscal and monetary stimulus.....
Total volume (21 day ave.) has contracted from 1.8 billion shares a day to 1.2 billion shares, since the stock market rally began in March. This is unusual since volume has historically increased in a new bull market. But the stock market is a bit like the line of scrimmage in football. Whichever teams controls the line of scrimmage, usually wins (turnovers aside). In the stock market, the line of scrimmage is formed by the balance between buying pressure and selling pressure. It must be noted that buying pressure almost always holds the stronger hand, since the investment game is skewed by the buy and hold philosophy. Investors are counseled to diversify and buy and hold, through good times and bad times. Large institutions consider cash a performance burden, so they must be motivated by adversity to increase cash. As psychology shifted last spring from fearing bad news to expecting less bad news, selling pressure dried up. It takes only a small amount of buying to push stock prices up when selling pressure is low. Buying has been further reinforced by short covering. During July’s rally, short interest in Nasdaq stocks fell by 5.1%, and 10.3% on the NYSE.
As forecast since March, GDP will be positive in the fourth quarter, and maybe in the third quarter, if inventory restocking kicks into gear. That now appears likely, as the success of the cash for clunkers program will boost auto production in the third quarter. As discussed last month, the National Bureau of Economic Research could determine that the trough of this recession was reached in July or August. Although they won’t make their call until next year, they determined the last two recessions ended in the month preceding an increase in Industrial Production, which did tick up in July. The more important point is not when NBER says the recession ended using a rear view mirror, but that coming economic data points are going to continue to show improvement. As it has, the stream of less bad stats will keep selling pressure low. Even if the double dip economists are eventually proven right, in the short term, the rally in the stock market can continue, as selling pressure remains muted, and buyers control the line of scrimmage.
Since we won’t know for a number of months whether a self sustainable recovery is at hand, or a double dip, combining technical analysis with fundamental analysis could prove valuable, as it did in October 2007 and March 2009. At some point, the stock market and economy will come to an inflection point, and the economy will have to deliver on the expectations for a recovery. As long as the advance/decline line and other measures of market momentum remain strong, corrections will likely be confined to a range of 4% to 7%. However, if breadth falters, the key will be how much selling pressure increases in response to disappointment. As long as selling pressure recedes quickly, and the advance/decline line rebounds to new highs, as it did in 2006 and the first half of 2007, the V-shaped recovery story will have legs. This is what has occurred after each short term high in the market since early May. If a selling squall is followed by a weak rally, the odds of a self sustaining recovery will diminish.......
....I am surprised that so few economists and strategists incorporate technical analysis with their fundamental work, since it can provide additional validation and understanding of when the stock market will take heed of coming economic turning points.
Link: http://www.ritholtz.com/blog/2009/09/how-technical-analysis-can-improve-fundamental-analysis/
posted by CR English at 6:56 AM
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