The Danger of Ignoring Technical Analysis

The cyclical recovery that began in March 2009 has been impressive but is getting long in the tooth.  Investors wonder when it will end, and while this can’t be known with precision there are signs that its terminus isn’t far away.

One sign this bull is getting old can be seen in Wall Street’s attitude toward practitioners of technical analysis.  Market technicians have never been highly respected on Wall Street and are usually accorded only second-class status in the research departments of large institutions.  About the only time technical analysts are given a hearing is in bear markets when the fundamentals stop working and everyone wants to know what’s going on with the market.  In desperation they turn to the despised technicians because they are the only ones properly equipped to navigate the treacherous waters of a cascading stock market.  As my mentor the late Bud Kress used to say, “In a bear market everyone becomes a closet technician.”

Powerful bull markets, like the one of 2009-2013, don’t require the input of technicians.  They make the fundamental analysts look good because a rising market can always be justified by strong corporate balance sheets.  Truth be told, most technical analysts tend to underperform the S&P in a bull market.  This is because of technical analyst’s emphasis on money management techniques such as tight stop losses.  A fundamental investor will normally ride out a correction in a bull market while a technician will get stopped out, having then to buy back in at a higher price.

Where technical analysis (TA) justifies itself, as mentioned earlier, is in bear markets.  An accomplished technician can slide effortlessly into a bearish posture and profit from a market decline while the typical fundamental investor remains “long and wrong” and often rides the decline all the way down.  The reason why a technician can see a bear market coming while a fundamentalist can’t is because the fundamentals invariably look rosy at the top of a bull market.  Moreover, it usually takes at least one to two quarters for fundamental deterioration to become evident in corporate income statements.  By then of course it’s too late. 

The technician by contrast sees the warning signs of a topping market, such as waning momentum and internal diverges, through the lens of technical indicators.  He’s thus in a much better position to act before the bear becomes firmly established and begins ravaging the “fundamentally sound” investment positions of the buy-and-hold crowd.  This is when the technician begins to garner the begrudging respect of Wall Street and he finally commands an audience among the naysayers.  Indeed, technical analysis is justified in a bear market.

Over the past few months there have been numerous signs that Wall Street has become complacent in this recovery and is shunning the useful services of the market timers.  You may have noticed, for instance, that Barron’s no longer quotes the writers of technical advisories in its weekly “Market Watch” column.  Apparently only fundamental analysts from major Wall Street institutions are now deemed worthy of mention in this column. 

A popular financial web site has also recently adopted a policy of allowing only discussions of fundamentals among its writers when analyzing individual stocks.  TA is in fact shunned by the web site in question, whereas not more than a year ago it was allowed if not welcomed. 

During the previous bull market prior to the 2008 financial crisis, fundamental analyst du jour Warren Buffett could barely contain his contempt for TA when he told an audience, “I realized that technical analysis didn’t work when I turned the chart upside down and didn’t get a different answer.”  A spokesman recently told The Washington Postthat Buffett still stands by that statement.

In the couple of years following the 2008 financial crisis technical analysis experienced somewhat of a mini boom in new interest.  According to the Market Technicians Association, there was a 30 percent jump in new members in the post-crisis years, expanding its rolls to a multi-year high of 4,500.  Interest in TA was boosted by the fact that during the last bear market, markets become correlated, meaning that macro events such as a debt crisis in Europe can quickly infect financial markets in other major countries.  Technical analysis is able to analyze such events in ways that traditional fundamental analysis is unable to.  It’s for that reason that while TA sometimes goes out of fashion with Wall Street, it will always come back in vogue once the Street is forced to reckon with its mistakes.

Gold’s recent crash also serves as a case in point of what happens when investors fall in love with a fundamental story and ignore the market’s technical picture.  Speaking of gold’s sell-off, Thomas Vitiello, partner at Aurum Options Strategies, told CNBC: “What happens is the fundamentals are there and it’s not responding the way you would think it would, so you have to look at that.” 

The above statement is typical of those who embrace an asset’s fundamentals without taking into consideration price pattern and internal factors.  Vitiello added, “You can’t buck the trend, but right here, how could you be bullish?”  This statement is reflective of the confusion that faces a fundamental investor after the price of his investment has crashed.  He sees that the fundamental picture hasn’t changed, yet prices keep dropping.  This serves to illustrate that in the near term the market is driven primarily by technicals, not fundamentals.

TA is the only reliable way to know when a bull market is in danger of reversing.  Fundamental analysis is of no use when it comes to timing the market, and if relied on to the exclusion of TA it will leave one holding the bag at a market top.  While fundamental analysis has stolen the spotlight from TA lately, the time is soon coming when Wall Street’s fundamentalists will be whispering to each other, “Psst, where are the charts?”

Momentum Strategies Report

The stock market recovery is nearly four years old, and investors wonder if it will continue.  While many experts have made forecasts for the coming year, few have been as impressive as the Kress cycles in projecting the market’s year-ahead performance since the recovery began.

Each year I publish a forecast for the coming year based on a series of historical rhythms known within Kress cycle theory.  Last year’s forecast was remarkably accurate in predicting the pivotal market turns, including the June 1 bottom in the S&P.

Here’s a sampling from last year’s forecast:

“The first five months of 2012 will likely be characterized by greater than average volatility....This will create a level of choppiness to coincide, if not exacerbate, the market’s underlying predisposition to volatility owing to the euro zone debt crisis…the May-June 2006 stock market slide could be repeated in May-June 2012.  Our short-term trading discipline should allow us to navigate this volatility and there should be at least two worthwhile trading opportunities between [January] and the scheduled major weekly cycle around the start of June 2012.  From there, the stock market should experience what amounts to the final bull market leg of the current 120-year cycle, which is scheduled to bottom in October 2014.

“Keeping in mind that like snowflakes, no two markets are exactly alike, the Kress cycle echo analysis for 2012 tells us to expect a final upswing for stocks in the second half of the year with the first half of 2012 likely to be more favorably to the bears, especially if events in Europe are allowed to get out of hand.”

 

This is your opportunity to find out what the Kress cycles are telling us to expect for 2013.  Subscribe to the Momentum Strategies Report now and receive as my compliments to you the 2013 Forecast issue.

In addition to that you’ll also receive the MSR newsletter emailed to you each Monday, Wednesday and Friday.  MSR provides reliable forecasts and analysis of U.S. and global markets based on internal momentum, cyclical and technical factors.  Low-risk stock and ETF recommendations are also made based on my proprietary system of selection.  Specific entry and exit instructions are also given for each recommendation.

[For the complete 2013 Kress cycle forecast for the U.S. stock market and the latest newsletters, subscribe to the Momentum Strategies Report at the link below.]

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Clif Droke is the editor of the three times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock sectors, natural resources, money supply and bank credit trends, the dollar and the U.S. economy.  The forecasts are made using a unique proprietary blend of analytical methods involving cycles, internal momentum and moving average systems, as well as investor sentiment.  He is also the author of numerous books, including most recently “2014: America’s Date With Destiny.” For more information visitwww.clifdroke.com