where we are now…(ii)

My first post in this series: interest rate movements will continue to have a major business-cycle-related influence on both stocks and bonds, but the gigantic tailwind for stocks created by the 40-year decline in rates from 20%+ to zero (and below that in the EU) is behind us.

using stock/index price charts

There’s a whole pseudo-science of chart reading, dealing with individual stocks as well as indices, in all the world stock markets I know of. The book everyone in the US or Europe ends up relying on is Technical Analysis of Stock Trends, by Edwards and Magee, published in (I think) the late 1930s. My skimming through the book at the other end of the link above suggests its the guts of the one I read in the late 1970s, but I can’t say what changes, if any, have been made to the original.

Why to investors use charts? Several reasons:

–in some markets, particularly in emerging economies, financial statements are either highly unreliable or non-existent. So charts are all the typical investor has

–charts can have value in describing the relative bullishness/bearishness of the market, especially around emotional extremes–at tops and bottoms

–in some cases, unusual trading activity can be evidence of either a corporate action (e.g., a developing takeover fight) or as-yet undisclosed problems in a company. So the trading is a signal to do some investigation

–in markets, again mostly smaller ones, where syndicates of wealthy market players operate “pump and dump
schemes, unusual trading activity can indicate this as well

–technical analysis is faster/easier to learn than fundamental (economic + accounting) analysis and it uses weird, cool words to describe things

One further caution:

In the mid-1980s I was hired by a small mutual fund organization to fix its broken global fund. During my first week, I discovered–as had the brokers he routinely dealt with–my predecessor thought his main source of value-added was his ability to “read” price charts. His “strategy” seems to have been to find companies whose stock had recently dropped like a stone–i.e., had a decline that was so sharp and so deep that all possible bad news must already have been discounted in the price. So, he thought, he would buy and wait for good things to happen (since all the bad had already occurred).

As the first step in an overall analysis, seeking out extreme emotional reactions and possible bouncebacks isn’t a bad idea. It’s not for me. But it’s what deep value investors do.

In this case, however, the manager appeared to just buy ugly-looking charts.

Once the sell side understood what he did, brokers began to give him what he wanted. They expanded the Y axes of charts they sent him and contracted the X so that even a slow wasting away looked like a trainwreck. He never noticed, though.

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