As we turn over another year on our calendars, it is the traditional time to take stock of what has happened and look forward to prospects for the new year. While our message is primarily intended for individual investors, many traders and fund managers will also benefit from an open-minded consideration (or re-consideration) of this information.
We always start with the fundamentals. By "fundamentals" we mean looking at the prospective returns of potential investments in a way that can be quantified and tested over time.
Some analysts narrowly define technical analysis and think that everything else is "fundamental". Here is a list of things that are not "fundamentals" by our definition:
Perennial concerns about old subjects -- war, famine, pestilence, debt, current accounts deficit, etc. Market hypotheses like seasonal variation, the Presidential cycle, comparison of various "recovery cycles." Complaints about government conspiracies or shortcomings in economic data.
These things are not technical analysis, but they are also not fundamental analysis unless the impacts can be quantified in terms of expected returns.
Looking at fundamentals leads one easily and directly to market valuation measures based upon expected returns. This is an excellent periodic exercise for three reasons:
1. It is the best gauge of long-term sentiment. We have suggested that short-term traders are too focused on narrow measures of sentiment. Everyone wants to be a contrarian. Most investors need to think about whether euphoria has seized the market, as it did in 1999, or whether valuations reflect undue pessimism. The standard sentiment indicators do not help with this subject.
2. Valuation helps with questions like "Is it too late to invest?" and "Is this a market like 2000?"
3. Valuation can help us interpret economic and market history.
Our 2007 forecast will begin with our own valuation work, take a look at recent market history, discuss sentiment, and culminate with comments on the best ideas for 2007.