Market Timing: Fundamentals And The 'Secret' About Technical Analysis

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Includes: AAPL, BB, GS, SPY
by: Carlos X. Alexandre

Market timing, a misunderstood concept, is often the subject of attacks, especially when stocks stop delivering the highly touted average annual return of 6% or 7%. It’s as if one is saying “if you’re not getting it, don’t try something else.” I was reading an article at MarketWatch that started by posing a simple question and answer: “Think you can time the stock market’s shorter-term gyrations? You may want to think twice, even thrice ...”

What is different about the statement as compared to earlier versions? The word “shorter-term.” Before the claim was far broader and encompassed all terms, and it appears that an implied acknowledgment of “longer-term” timing may be plausible. The example used in the article is potentially the worst case scenario that could be found, and refers to an unnamed adviser’s forecast just before the Lehman bankruptcy in 2008.

“'I am ready to be a bull again! Not now of course, the exact time is still difficult to tell, and we will in all likelihood be early to the game, but three crucial elements necessary for a new bull market are getting our attention. The housing market is beginning to show serious signs of a bottom. … Quietly, the financial sector has been slowly healing.' His timing couldn’t have been much worse, of course."

Once again, what is wrong with the "timing" premise? Market timing is not about talking, much less about the interpretation of economics, but about listening. And coming from me, a guy who never seems to shut-up through his writings, it’s hard to believe. However, many seek glory by predicting market crashes and bull runs, while the quiet ones pay attention to supply and demand, the true fundamental information about any stock.

But the investment world is still dominated by myths and individuals that try to suppress creative thinking and any idea that challenges the “status quo” – until the “Egg of Columbus” challenge arrives, that is. Furthermore, extrapolating economic analysis to short-term market movements is just plain wrong and shows a complete disconnect from reality.

Traditional fundamental analysis has its place, but it becomes stale quickly, and by the time the financials are published, three weeks or more have already passed, and the numbers may not be a reflection of what is taking place. Then there’s valuation, and Apple (NASDAQ:AAPL) is potentially the best example of all. I don’t question the logic behind the stock’s potential for further appreciation, and the company is without a doubt an industry leader, but when I listen to the market, the collective wisdom of investors have set a ceiling around $400 for the time being, even if one can state that it’s underpriced. However, and as of late, supply and demand are showing that the run to the top is on, and the all time high could be conquered.

And that leads us to the technical analysis side of the business, which is viewed by many as an endless collection of lines that collectively amount to nothing. But it’s not just about support, resistance, averages and a host of other indicators, but rather a graphical representation of supply and demand – or fundamental capital flows and ultimately investor sentiment, as I prefer. How the data is read and interpreted has many flavors – some sweet, some bitter.

So why does technical analysis add an edge, even outside the capital flow consideration? It’s not derived from its magic powers, but rather because there’s a consensus and acceptance, and enough traders believe in it and react to the same signals. That’s the secret, and it’s not a science like some like to portray it.

As an example of different interpretations, I was reading an article on Seeking Alpha about Research in Motion (RIMM) which delivered the author’s opinion from a fundamental and technical perspective. In short, the author issued a cautious “Trend Spotter buy signal,” but when I looked at the charts, all I could see was that investors were heading for the door days before the earnings announcement. If I had an interest in the stock, I would have never bought it at that point in time, especially from a risk management perspective. If the crowd turned out to be wrong and RIMM had exceeded expectations, I would have only lost an opportunity which can be easily replaced by others. Money is a bit harder to replenish.

The problem with this approach is that if one has a good call, a guru is born. If a miss takes place, scorn will come one’s way, and there’s no other business on the planet that draws so many disparaging remarks when a misstep is taken.

The news that Goldman Sachs (NYSE:GS) closed its Global Alpha fund, a computer-driven quantitative trading system, will only add to the argument against the misinterpreted definition of market timing, but as history as shown us, the big investment houses are not immune to failed strategies. For the fund to lose 40% in 2007 when Goldman Sachs was knee deep in information not available to you and I, only highlights the fact that the algorithm is flawed. In addition, the U.S. stock market has presented investors with one of the toughest environments since February.

Listening is the key, and the stock market should be viewed like a retail business. The executive team’s decisions on what merchandise to carry in their stores does not hinge on their personal preferences or opinions, but rather on the wants and needs of the market they serve.

Lastly, the focus on large returns is also misplaced, and I see plenty of claims and projections for 20%, 50%, even 100% returns for specific equities. But the mention of risk is never there, and that’s what brings credibility to any forecast, and its absence should raise a red flag.

The reality for the common folk comes down to this. If an investor placed $1,000 on the S&P 500 index ETF (NYSEARCA:SPY) between 2000 and 2010 – also known as the lost decade - the money would have grown to $1,035, including dividends. If a “timing” strategy was used and a return of only 6% was attained for every single year, without dividends, the end result would be $1,898 – or 89% vs. 3.5%. Granted that many continued to contribute to their retirement accounts every month, and have absolutely no idea of the return they actually received.

Yet one can marvel at S&P 500 returns of 28% in 2007 and 27% in 2009, and claim that we’ll be alright. Nevertheless, I will continue to listen to what markets have to say, because the collective thoughts, and resulting capital flows of everyone out there, trump my opinion any day. And the goal is to succeed in growing my wealth, not to become Time magazine’s “Man of the Year.”

Thus, greed is not good, and if it turns out that one can make more than the average 6%, celebrate in silence.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.