Fundamentals are late to the Party

...Most members of this community already know the differences between fundamental and technical analysis. Some prospective members may still be confused and that is completely understandable since main stream analysts still focus on “the numbers” rather than the charts. Turn on any major network news station and you will become bombarded by fundamental analysis and strong opinions based on these numbers and nothing else. Occasionally I will see a basic line chart posted on the screen without any study or analysis from the “talking head”. In addition to not focusing on charts, these analysts tend to concentrate on the same 5-10 stocks each and every day (the most famous large blue chip stocks). It disturbs me that the “buy and hold” strategy is still the predominate scenario discussed on the major news networks and newspapers across the nation.

Reading corporate financial statements is an excellent skill for every investor but making short term buy and sell decisions based from this information can be costly. In my opinion, a short term trade is less than one year. A stock usually breaks down well before the actual fundamentals turn negative and official news hits the street. Insiders always start to sell when things are looking down or sales are not expanding. This poses a problem for the individual investor because they won't know about poor sales or earnings until the official news is published or the company changes their outlook in a conference call, months after the problem has already developed.

You now ask: How can I sell before the fundamentals crash?

It's called technical analysis, a study of chart patterns that allows the investor to see if a company may be heading in the wrong direction or sideways pattern after an extended up-trend. Fundamentals make you aware of a particular stock to purchase as sales and earnings are rising quarter over quarter and year over year but they don’t get you out of the stock before the floor drops. Just because a company has excellent earnings or a perfect track record, doesn't mean you buy immediately. You may be buying after an extended up-trend while the stock is due for a correction before its next up-trend. Nobody knows how long a correction will last; it can be 8 weeks, 8 months or 18 months. Why would you park your money in an investment that is stagnant or can possibly lose money for an extended period of time? This is the typical buy and hold strategy that the analysts tout to novice investors.

For example, if you bought Microsoft exactly five years ago today at $47.21, you would be down 54%. Yet, every network TV and radio broadcast mentions MSFT’s ticker price every night as a highlighted stock. Many analysts have said to buy as MSFT has fallen over the years. This seems to be dead money to me. I have found a lot more success buying young innovative stocks that are growing at clips similar to the numbers Microsoft boasted in the late 1980’s and 1990’s. A few other nightly favorites include MRK, CSCO, INTC and so on, take a look at their five year charts – I wouldn’t touch them with a 10 foot pole!

Technical analysis can help you spot red flags such as distribution days, breaking of support lines or slicing of moving averages. The most recent fundamentals may still be stellar but the charts will be well ahead of the numbers, flashing multiple sell signals. It is imperative that the intelligent investor sells based on the information coming from chart analysis. The buy and hold investor will not sell or even be aware of the current situation on the charts leaving them vulnerable to costly drops in price that may take years to recuperate. The talking head on TV may still recommend the stock but that is because they don’t understand that fundamentals are priced into stocks six months in advance. The technical investor will see the trouble arising and can take action well before the “bad news” hits the street. The technical investor won’t know what this bad news will be but they know it won’t be good and that is the most important fact.

When red flags are flashing in every direction, sell and wait to see how the stock is going to react and what news is on the horizon. Sooner, rather than later, negative news will come out from the company stating that sales have slowed, a contract was lost, a drug was not approved, or maybe the CEO is resigning. Whatever the negative news may be, as soon as it hits the headlines, fundamental analysts will be talking their heads off at how it may be time to sell (even though the stock is now many percentage points below the key sell signals flashed on the charts). The stock has usually dropped dramatically by this point but the numbers have not been updated until now, the time the whole free world can now sell for a significant loss. On the other hand, the buy and hold investor will usually just hold and claim that they broke even or made a profit several years in the future. Who cares if you make 25% or 50% over a 5 or 10 year period. Don’t allow a loss of 10% snowball into a 50% drop in your portfolio. It might take Microsoft another 5 years or more just to break even to the $47 level. That would make 10 years or more for the poor sole that bought exactly 5 years ago today.

The point of this blog is to promote heavy use of technical analysis while investing and deciding to sell on red flags! I use both fundamental and technical analysis to make decisions in the market and believe that both tools give you an advantage over the investor that only uses one of these tools.

Piranha