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AA, ALCOA: WE'RE SHORT AA -- DIFFERENT LOGICS BETWEEN FUNDAMENTAL AND TECHNICAL ANALYSIS

I'm writing this instablog on short notice to provide a picture to some readers about why we are negative on AA.

Below is a response to a specific defender of AA, who argues my opinion is not 'logical' because I don't speak the same language he and the investment establishment speaks, mathematical fundamental analysis.

I realize you are in love with AA, which is breaking the first rule of investing -- never fall in love with a stock -- and that I am attacking your sacred cow.

My prediction is that AA will be below 10 before it is above 20. Simple prediction, either right or wrong. All the rationalization you do with fundamental company data is just that -- rationalization, a form of a prayer. Your reciting margins and EPS and debt level and cost per ingot is just a form of prayer and says nothing about where the stock is going. It is an incantation you make defining where you want the stock to go. You have come to believe that fundamentals drive the stock price; in truth, investors' GREED drives the stock price up, investors' FEAR drives the stock price down.

Fundamentals may be a fuel for the GREED, but not always. Often, stocks with good fundamentals tank, completely collapse. Because FEAR eclipses GREED. Likewise, a company with horrible fundamentals can soar. We can all remember the NASDAQ bubble in the late 1990s, during which time internet stocks with no earnings were trade at astronomical multiples -- until the GREED ended in a crash. GREED is an inverted FEAR in truth -- FEAR of missing the bus, FEAR of not getting what everyone else is getting. FEAR is an inverse of GREED also -- the FEAR OF GREED being shut off, and one's not getting when he deserves.

The fundamental picture of a company is ALWAYS a picture of the past -- even the fundamental indicators that claim to peek into the future (future earnings projections -- projections being the key word) just extrapolate the past and present into the future, an not very effectively, since future earnings projections for the last 10 years are almost always being dumbed-down to not frighten investors when actual earnings are announced. Stock buybacks help companies report growth, even when earnings are not growing; a company can either, to report EPS growth, actually grow earnings (sales, revenues) or simply reduced the outstanding shares component of the equation. They can lose money but reduce shares and still report earnings grown -- and ZIRP makes this very easy and relatively cheap to do, certainly cheaper than telling the truth.

So how do we gauge the transition of investor GREED into investor FEAR? Well, interest rates are a key gauge of GREED/FEAR transition mechanism. But they are not the only one. There are others also. FEAR generally can overtake a bull market, since Fear of war, political collapse, depression also weigh into the balance.

Fundamental equations are often helpful in telling the investor WHICH stock to buy, but rarely if ever WHEN to buy, and especially not WHEN to sell. Value is a guide, but not a very useful guide: one can buy an undervalued stock and sit on it for two years waiting for it to move. When a stock gets overvalued, and the investor sells for a profit (perhaps) he may watch the stock double or even triple after he sells, because valuation is a very crude trading instrument.

I think you are just defending a convention. Conventional wisdom is always conventional (I want to belong to the big, successful group that speaks the big fundamental language) but very rarely wise.

So, I don't believe in your logic. Why should I participate in this thinking. I believe your logic is a false prayer. As with any discipline or learning, it has value as a discipline, as does technical analysis have value as a learning discipline.

In a bull market, when all boats are lifted by the tide, fundamental analysis seems like the law. Investors apply the rules of fundamental analysis to stocks, and stocks go up; and investors believe there is a causal relationship between their religion and the wealth-results. But it this really a causal relationship; or is it a coincidence? In the Bear Market, that faith breaks down. So get ready. You've probably never been through a real Bear Market. It won't be pretty. It will shred a lot of companies that have pretty good fundamentals (when the selling begins).

I use technical analysis to try to view, directly, the struggle between FEAR AND GREED, between sellers and buyers, in a specific stock. At the moment, in AA, there is more FEAR than GREED. That is what I'm saying, what I am seeing. Your fundamental positives are all weighed on the GREED side; but there are more FEARS about future fundamentals and about macro liabilities (the strong dollar being one).

Technical analysis is also mathematical. But it is more about measuring psychology in the market than about measuring the body (with the hocus-pocus logic of fundamental prospects).

Here is a picture of Alcoa, showing why we believe it is heading down, perhaps below 8 in 3-4 months:

Both Fundamental and Technical analysis are prayers of a sort. I have no problem with this. Choose your own instrument. And pray with diligence in order to be saved.

Good luck trading.

MJC, CGTS

Disclosure: The author is long OCTOBER PUT OPTIONS ON AA.