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Fundamentals x Technicals
In our line of business, which is to say publishing ideas on stocks, there are two broad-brush methods of analysis. Fundamental analysis looks primarily at things that appear to be real, like macro backdrops, company earnings, revenue trajectory, balance sheets, all that gumbo. Technical analysis considers things in the not-real realm, primarily colored lines on charts. If one leans to the scientific, as we do, it is easy to place primary reliance on fundamental analysis. After all, numbers are real, scientific and meaningful, and charts? They’re some kind of magickal trickery, a shamanic attempt to convince a rational world that other-worldy forces are at work. Right?
Stock prices are fascinating things if you like numbers. Over and above the actual making and losing of money, if you leave your wallet at the door and step into the world of your brokerage screen, an inquisitive mind cannot but be fascinated by the movements and machinations going on in there. Who wouldn’t seek to understand what moves prices? The key is to leave emotion at the door. Imagine it was all a math exercise and money wasn’t involved. You’d want to know, and you’d put time and thought into it, quietly and slowly. One’s hopes, dreams, fears and desires aren’t all rolled up into math problems the way they can get to be into one’s money matters.
In our stock by stock analysis and our staff personal account investing, we use both fundamental and technical methods. And whilst we’re a long way from getting it right every time, we get it right more than we do wrong, and when wrong we tend to be wrong smaller and right bigger. Good for us. In pursuit of continuing to get it right more often, something that has occupied our attention for a while now is when to lean toward fundamentals and when toward technicals.
We are as unemotional about this question as we are about stock prices themselves. We love no stock and we have no particular dog in the fight between analytical methods.
Books on analysis tend to religion and so offer little help as to which method to choose at any particular time. There are some excellent tomes on technical analysis of which our favorites are Elliott Wave based. From the deceptively simple Tramline Trading by Burford to the classic Elliott Wave Principle by Frost & Prechter to the magisterial Socionomic Theory of Finance by Prechter, to read these is to step into a world where stock prices are themselves a closed system, providing everything you need to know about the stock price from the stock price itself. Gloriously postmodern. And whilst we do agree with the basic premise of the method - that exogenous events are barely related to stock prices - it’s not a whole answer. Because sometimes real things do matter to stocks.
There are probably similarly deified publications on the fundamental method too, but we haven’t read them, since the school into which we were inaugurated taught the primacy of company financial statements, and we don’t need more reading on that faith. Heck, we already spend time churning out parts of the 10-Q that other analyst services can’t reach. We know that sometimes financial statements matter to stocks. But we know that it’s not often that they do. So again, this side of the dyad isn’t a whole answer.
These schools are diametrically opposed to one another. Fundamentalists believe chartists to be quacks; chartists believe fundamentalists to be delusional. This is all great if your stock in trade is to sell books. But what if your stock in trade is, er, stocks? Then religious argument is of no use to you. What you need to know is, is that stock there going up or down, when, and why? Questions of this nature can be answered with regard to planetary bodies and quantum waves; why not simple stocks?
One day, as is the hope in physics, perhaps there will be a Grand Unifying Theory of Everything. Until then, as academics like to say, further work is needed (translated: hopefully further funding can be justified).
For the most part, one cannot explain stock prices by financial statements. The simple wild moves of stocks on earnings reports tells you that is true. For any given stock on any given quarter in any given market environment, good earnings and guidance can move a stock up, down or sideways. And bad earnings and guidance can move the same stock up, down, or sideways. We can all then assign ex post facto rationale to the move. But in truth nobody has a Scooby’s why the stock moved that way on that particular report.
Equally, whilst Elliott Wave and other chartist methods are compelling in their rejection of the fundamentals-move-stocks assertion, and there is absolutely some explanatory power as to the limbic-psychological tide that Wavists believe moves markets, this isn’t a whole answer either. If it was, Robert Prechter would be sat upon a diamond-encrusted throne atop one of the many Hawa'iian islands he would have purchased by now, throwing down commandments to his subject-followers. He wouldn’t still be pushing 500 page religious texts on Amazon. (As one of our subscribers recently noted, since there are no trillionaires on Earth, literally everyone sold too early).
Our own view is that at a high level of abstraction - particularly indices, commodities, currencies and the like - the limbic system does indeed drive prices. Whether the trading instruction set is manual or algorithmic matters not, since all the underlying rules, boundaries and logic are first formed in wetware and only the location of the executable differs.
But there is one aspect of fundamentals that does matter, and that aspect is cash. It only matters in the limit. But then the limit is always where all the really interesting action takes place. The middle part of the curve, not so much.
Cash is required to:
- Service debt, and
- Pay dividends, and
- Fund operations.
You can reward stockholders with a move in stock prices, bondholders with a move in bond prices, you can even pay employees with stock. Such things can be magicked up from chart-land. But those three things above? Old-skool fiat currency still matters and you have to have enough of the stuff at hand.
If companies encounter difficulties in servicing debt, paying dividends, or funding operations, meaning swings in working capital and capex - or indeed if the market thinks companies might encounter such difficulties based on their most recent financial statements, you can be sure that stock prices will react accordingly. Doubt that? For an in-the-limit case, check the price history of Maxar Technologies (MAXR) in the chart below. Not enough cash in a highly levered situation? Kiss goodbye to the stock as lenders prise it out of your hands. Cash balances and sentiment theretoward have been a major mover of MAXR stock on this basis. The Cash Nexus, ladies and gentlemen. Fundamentals and technicals in lockstep.
Now, we need to get back to developing that Grand Unifying Theory. If we crack it, you’ll know. Because we’ll be either be sat on that Hawa'iian island chain tweeting photos like there’s no tomorrow, or, you’ll see our book on Amazon. One or the other. Until then, back to work!
Cestrian Capital Research, Inc - 6 April 2021
Disclosure - Cestrian Capital Research, Inc staff personal account(s) hold long position(s) in MAXR.
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