Fundamentals are only half the story

WSJ this morning, as stocks sell off around the world:

“It’s a very skittish market,” said Wouter Sturkenboom, senior investment strategist at Russell Investments, which has $266 billion under management.

“A few months ago people saw down moves as an opportunity to start adding. Now, as soon as they see a down move they sell and sell hard,” he said, adding that Russell has reduced holdings of stocks in some of its multiasset funds in recent days.

Why are the dips being sold and not bought? What changed from “a few months ago”? Not fundamentals. Psychology. The positive feedback loop has been broken. This is the thing the fundamentalists miss.

You can bury your head in 10q’s and 8k’s and memorize a thousand facts about a company. You can become an expert on a given stock sector and establish relationships with all of the executives who run the show. You can build your own DCF models and outguess the other guessers on earnings estimates and forward guidance.

But until you accept that market mood and behavior is as big a factor as the fundamentals, you won’t ever be completely honest with yourself.

The E is only half of the PE. No matter how good you are at understanding and predicting the E, you’ve still only got half the story.

The P is determined entirely by psychology. Are the buyers more sentimental than the sellers. Do the bulls feel more strongly than the bears? These are the questions that give you an answer on where the P in PE may be headed.

How do you get to those answers? You can’t very well walk around town asking every investor their opinion of a given market or sector. There’s not enough time in the day.

You can’t rely on surveys either, they are stale within a moment of being published. Surveys are conducted amongst people who are constantly lying to themselves, saying one thing in public and doing another in private. People are horribly bad at predicting what they themselves will do in the future. They go out of their way to present their current actions to others in a certain light.

You also can’t believe the analysts. They’ve got hundreds of different career-related pressures that you could never truly understand until you’ve been in their seat. Gotta keep a positive outlook on the company to please the execs, or else they lose “access.” Gotta be constructive because the company they’re covering is a top banking client of the firm, just can’t make it look obvious. Gotta downgrade the stock because a big trading client is trying to buy-in a short position this week. Gotta keep their estimates in-line with The Street because it’s dangerous for their employment to be an outlier and become very wrong.

So what can you go by to figure out the mood and psychology around a stock or a market? There’s only one thing: Price itself. And the numerous derivations of price – momentum, relative strength, volume, advancing vs declining issues, moving averages, historical levels of significance.

What you are seeing in price is market psychology writ large. The emotions and attitudes surrounding a given investment are being splattered before you on a canvas. All of the fundamental data that you and others could possibly be aware of is being reflected in the lines on the chart, all day every day.

When you look at these items, they don’t scream out a binary yes-or-no, buy-or-sell answer at you. But they tell you everything you need to know about how people feel. They give you clues to arrive at where the P in PE is headed. Some clues are more valid than others at different times and all clues can fool you. Something that was significant on Tuesday can be an utter red herring on Thursday.

But this is what you have to work with.

Fundamental analysts are constantly using technical analysis without realizing it. Sometimes it comes down to terminology – a favorite name is “oversold” according to its boosters. A falling market has perhaps “found support” say the hopeful and potentially hopeless.

Sometimes it’s deeper than that – an extrapolation of trends in business momentum or consumer behavior. A product is seeing an acceleration in sales as more customers become aware of it. A competitor in a given industry is poised to continue taking market share from others, as judged by the rate of share taken in a previous quarter. This is technical analysis in that it is studying the behavior of buyers and sellers within a market, albeit a physical one rather than one made up of securities.

A technical study of stock prices is the numerical manifestation of supply and demand playing out across your screen. And what could be more fundamental than supply and demand?


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