technical analysis in the 21st century

A reader asked last week what I think about technical analysis.  This is my answer.

what it is

Technical analysis in the stock market is the attempt to predict future stock prices by studying current and past patterns in the buying and selling of stocks, stock indices and associated derivatives.  The primary focus is on price and trading volume data.

Technical analysis is typically contrasted with fundamental analysis, the attempt to predict future stock prices by studying macro- and microeconomic data relevant to publicly traded companies.  The primary sources of these data are SEC-mandated disclosure of publicly traded company operating results and government and industry economic statistics.

what the market is

The stock market as the intersection of the objective financial/economic characteristics of publicly traded companies with the hopes and fears of the investors who buy and sell shares.  Fundamental analysis addresses primarily the companies; technical analysis primarily addresses the hopes and fears.

ebbing and flowing

To be clear, I think there’s an awful lot of ridiculous stuff passing itself off as technical “wisdom.”  The technical analyst’s bible (which I actually read a long time ago), the 1948 Technical Analysis of Stock Trends by Edwards and Magee, is now somewhere in my basement.  I’ve never been able to make heads nor tails of most of it.

On the other hand, in the US a century ago–and in markets today where reliable company financials aren’t available–individual investors had little else to guide them.

the old days–technicals rule (by default)

What individual investors looked for back then was unusual, pattern-breaking behavior in stock prices–because they had little else to alert them to positive/negative company developments.

I think this can still be a very useful thing to do, provided you’ve watched the daily price movements of a lot of stocks over a long enough period of time that you can recognize when something strange is happening.

the rise of fundamental analysis

Starting in the 1930s, federal regulation began to force publicly traded companies to make fuller and more accurate disclosure of financial results.  The Employee Retirement Income Security Act (ERISA) of 1974 mandated minimum levels of competence in the management of pension plan assets, laying the foundation for the fundamentals-driven securities analysis and portfolio management professions we have today in the US.

past the peak

The rise of passive investing and the rationalization of investment banking after the financial crisis have together reduced the amount of high-quality fundamental research being done in the US.  Academic investment theory, mostly lost in its wacky dreamworld of efficient markets, has never been a good training ground for analytic talent.

The waning of the profession of fundamental analysis is opening the door, I think, to alternatives.

algorithmic trading

Let’s say it takes three years working under the supervision of a research director or a portfolio manager to become an analyst who can work independently.  That’s expensive.  Plus, good research directors are very hard to find.  And the marketing people who generally run investment organizations have, in my experience, little ability to evaluate younger investment talent.

In addition, traditional investment organizations are in trouble in part because they’ve been unable to keep pace with the markets despite their high-priced talent.

The solution to beefing up research without breaking the bank?  Algorithmic trading.  I imagine investment management companies think that this is like replacing craft workers with the assembly line–more product at lower cost.

Many of the software-engineered trading products will, I think, be based on technical analysis.  Why?  The data are readily available.  Often, also, the simplest relationships are the most powerful.   I don’t think that’s true in the stock market, but it will probably take time for algos to figure this out.

My bottom line:  technical analysis will increase in importance in the coming years for two reasons:  the fading of traditional fundamental analysis, and the likelihood that software engineers hired by investment management companies will emphasize technicals, at least initially.

 

 

 

 

Tesla (TSLA) raising funds

Last week TSLA announced that it is raising $1 billion in new capital, $750 million in convertible notes due in 2022 + $250 million in common stock.

The offering itself isn’t a surprise.  TSLA has been chronically in the situation where analysts can see a point on the near-term future where the company could easily run out of funds.  This is partly the lot of any startup.  In TSLA’s case, it’s also a function of the firms continuingly expanding ambitions.  Elon Musk has been saying for some time that TSLA will will need new capital, too.

What is surprising, to me at least, is that the offering is not bigger   …and, more significantly, that the stock went up on the announcement.

To the first point, why wouldn’t TSLA give itself some breathing room by raising more money?  Of course, it’s possible that the small size is a marketing tactic and that the underwriters will soon announce that, “due to overwhelming demand,” it’s raising the size of the offering to, say, $1.5 billion.  Otherwise, I don’t get it.

To the second, this is just weird.  TSLA shares rose by a tad less than 30% in the first six weeks of 2017 and have been moving more or less sideways since.  So the idea that investors are willing to buy the stock can’t be surprising positive news.  And I don’t see the plus in some commentators’ claims that the market is relieved the offering isn’t larger.  I think the market should be mildly concerned instead.

Something else must be going on.

The only thing I can think of is that Wall Street is beginning to believe that electric vehicles are going to enter the mainstream much sooner than it had previously thought.  At the same time, the Trump administration’s intended moves to make it easier for American car makers to sell gas guzzlers for longer may result in Detroit remaining stuck in the past, paying less attention to electric vehicles.  So market prospects for TSLA may be improving just as competition from the “Big Three” may be weakening.

However, that alone shouldn’t be enough to propel a well-known stock higher in advance of an offering.

 

 

 

The kinks of financial journalism

This is the tile of a 2014 paper by Prof. Diego Garcia of the University of North Carolina, in which heanalyzes the relationship between recent behavior of the stock market and subsequent reporting in financial newspapers.

Conventional wisdom holds that reporters’ articles mirror and perhaps intensify the tone of the recent past.  That is to say, they are unduly bearish when the stock market has been making losses, and similarly unduly bullish when it has been making gains.

Prof. Garcia, studying Wall Street as reflected in the Wall Street Journal and the New York Times from 1920 to 2005, draws a different conclusion.  He writes:

“…the asymmetry of journalists’ writing is pervasive: it has barely changed from the 1920s to the 1990s, and virtually all authors exhibit the same pattern, emphasizing negative returns, ignoring large positive market moves.”

Why should financial reporting have a negative bias?

The first thing that comes to my mind is television and radio weather people, who have a strong tendency to predict more precipitation than the US Weather Service, the government body from which they derive their data, says will happen.  How so?  Media weather people know that talking about looming bad weather has more entertainment value than a more benign forecast.  Also, viewers/listeners feel relieved if the forecast is for rain and the day is sunny instead.  They only get angry if the forecast is for fair weather and it ends up pouring.  Therefore, media weather people have every business/career reason to shade their forecasts heavily toward more precipitation rather than less.

John Authers, a reporter from the Financial Times from whom I learned about Prof. Garcia’s paper, gives more or less the same rationale for the similar phenomenon with newspapers.

my thoughts

–if the default position of a newspaper writer is to write a negative story, then we probably get no investment information from it.  On the other hand, if the story is positive, it’s unusual enough that we should look into the company or industry being reported on as a possible investment idea.

–Mr. Authers illustrates the risks to a journalist of making a positive recommendation.   Better, he says, to recommend not buying Amazon and watch it double than to run the risk of a loss.  Suppose the positive recommendation turn out to be Enron?

Of course, anyone in his right mind who read the Enron financials would have stayed as far away from that company as possible (yes, a couple of less-skilled colleagues at my last firm were, incomprehensibly to me, quite eager to buy the stock just before it imploded–and, yes, I did buy a stock certificate before it was delisted at $.80 or so as a souvenir–but that’s another story).  Reporters are trained journalists, however, not securities analysts.  They typically don’t have the economics, accounting or finance background to do analysis (although Mr. Authers does have an MBA from Columbia).  Nor do they have the time.  So the risk they run by saying something positive about a company is enormously high.

–An aside:  oddly enough, one of the first steps in training a growth stock analyst is to question this common sense attitude that avoiding all possibility of loss is the highest virtue.  For growth investors, finding a stock that can triple is.

–this study is only of US newspapers.  In my experience, reporters for the Financial Times are much more highly skilled than their US paper counterparts.

 

 

Tesla (TSLA), me and momentum investing

Why should a company fundamentals-driven investor have a problem with momentum investing?

Two reasons:

–momentum investing is a reactive strategy, and

–one that focuses son the past price movement of the little pieces of paper (or electronic impulses) that trade in the secondary market.

In contrast, fundamental investing is a predictive strategy based on the idea that the price of the paper/bits will ultimately be determined by the value of the underlying company.  Among fundamental investors, value investors believe that the key is the worth of the company as presently constituted (but perhaps running more smoothly than it in fact is).  Growth investors think the key is in early recognition of novel and unexpected profit positives that will fully emerge only in the future.

 

What kind of a thing, reactive or predictive, is my formula for TSLA of:   buy at $180 and sell at $250?  In a sense, I’ve got some fundamental underpinning.  My back-of-the-envelope figuring suggests nothing is likely to happen inside the company Tesla over the next couple of years that could possibly justify more than a $250 price.  And I’m willing to sell at that price even though the stock is still exhibiting positive price momentum.

But how did I get the $180?

What I’ve really done is to take a chart of the stock and draw a line that runs through the lows of the past four years or so and to conclude that this line forms the bottom of a channel (with something like $250 as the top) that TSLA has been navigating itself through since late 2013.  Yes, at $180 I have better potential for upside than I do at $250.  But that’s more a fact about arithmetic than a deep insight into corporate operations at Tesla.

In sum, then, the fundamental underpinning of at least the buying are pretty lame.

So I guess I have to say that there’s a healthier dose of momentum in my fooling around with TSLA than I might like to admit.  On another non-fundamental note, though, this ensures that my California son and I stay in regular contact.

momentum investing

what it is

Momentum investing is a style, if one can call it that, of buying and selling securities based simply/solely on recent price momentum.  If a given stock is going up, buy some.  If it continues to rise, buy more.  If a stock begins to decline, sell it   …or, for very aggressive players, sell it short.  No fundamental data counts.

Day traders and very short-term-oriented algorithmic players are the main people who use this simple buy-if-they’re-going -up, sell-if-they’re-going-down rule.  In my career, I’m only aware of two “professional” investment groups who have practiced momentum investing as their main strategy:  Wood Mackenzie trading oil stocks in the early 1980s, Janus trading tech stocks in the late 1990s.  The former was an almost immediate disaster; the latter had a surprisingly long period of success before going down in spectacular flames.

recent use

The term has come into recent vogue in the financial press as a description of growth investing.

It isn’t one, although it may reflect the jaundiced view a few (narrow-minded, in my view) value investors have of their growth colleagues.

To be clear, growth investors try to make money by finding companies that are expanding faster than the consensus expects.  This is not momentum investing.  Nor is the style of value investing that requires that a company not only be bargain-basement cheap but that there be a catalyst (reflected in positive price momentum) for change before buying.

why write about this?

A few days ago, a regular reader, Small Ivy, characterized my speculative dabbling in Tesla as momentum investing.  Maybe so, maybe not.  More tomorrow.

 

Snap (SNAP): non-voting shares (ii)

Two potentially important issues arise with non-voting shares.  The underwriters and prospective investors in SNAP are clearly not worried about them.  Granted, they’re unlikely to emerge as actual issues in the near future, but here they are:

–value investors often buy shares in companies they believe are undervalued by virtue of  having bad management.  Their rationale is that management will change in one of several ways:  existing managers will learn from past mistakes and improve;  the board of directors will replace existing managers with better ones; shareholders will vote out current directors and replace them with better ones; the company will be taken over by a third party, which will toss out the incumbents and replace all of them with more competent individuals.

In the case of SNAP, management, the board and the voting shareholders are basically one and the same.  The likelihood of them firing themselves is pretty small.  And the chances of a hostile takeover are zero.  So the value investor argument for eventually buying SNAP shares that there’s a level below which they can’t go without triggering change of control doesn’t apply here.  So if things turn south with SNAP, the chances of rescue are small.

The results of this situation are plain to see in the Japanese stock market, where disenfranchised shareholders have had to watch their investment in family-owned company shares lie dormant for decades.

–change of control can happen voluntarily.  But does an acquirer have to buy non-voting shares in order to take the reins?  I don’t know.  But I don’t think the answer is clearly “Yes.”  Say Amazon decided to bid for the voting shares of SNAP at double the price of the publicly traded, non-voting ones.  AMZN could presumably then replace management and the board of directors and guide the company in any direction it chose–without buying a single non-voting share.  If this were to happen, my guess is that non-voting shares would plunge in value.  Years of expensive legal wrangling  would decide the issue one way or the other.

A third musing:   Can SNAP declare dividends for voting shares but not for non-voting?  The answer should be in the prospectus, which I haven’t read carefully enough to have found out.  But then I’m not interested in taking part in the IPO.

Warren Buffett’s bid for Unilever (ULVR)

(Note:  ULVR is an Anglo-Dutch conglomerate with what is for Americans a very unusual corporate structure.  I’m using the London ticker.)

Late last week word leaked of a takeover offer Kraft Heinz (KHZ)–controlled by Warren Buffett and private equity investor 3G Capital–made for Unilever.  Within a day, KHZ withdrew its offer, supposedly because of a frosty reception from the UK government.  Not much further information is available.  In fact, when I checked on Monday evening as I was writing this, there’s no mention of the offer or its retraction among the investor releases on the KHZ website.  Press reports don’t even seem to acknowledge that Unilever is one set of assets controlled by two publicly traded companies.

In any event, two aspects of this situation seem clear to me:

–Buffett’s initial foray with 3G was Heinz, where the Brazilian private equity group quickly established that something like one out of every four people on the Heinz payroll did absolutely no productive work.  Profits rose enormously as the workforce was trimmed to fit the actual needs of the company.

Buffett subsequently joined with 3G in the same rationalization process with Kraft.

For some time, achieving stock market outperformance through portfolio investing has proved difficult for Berkshire Hathaway.  Tech companies are basically excluded from the investment universe; everyone nowadays understands the value of intangibles, the area where Buffett made his reputation.

The bid for ULVR shows, I think, the Sage of Omaha’s new strategy–acquire and rationalize long-established, now-bloated firms in the food and consumer products industries.

Expect a lot more of this, with any needed extra financing likely coming from Berkshire Hathaway.

–the sitting pro-Brexit UK government is showing itself to be extremely sensitive to evidence that contradicts its (questionable) narrative that Brexit is good for the UK.  That seems to me to not be true in the case of UVLR.

Sterling has fallen by 15% or so since the Brexit vote, creating problems for firms, like UVLR, which have revenues in sterling + euros but costs in dollars.  Since the Brexit vote, and before the revelation of the bid, UVLR ADRs in the US had underperformed the S&P 500 since last June by about 20 percentage points.  Yes, UVLR has been a serial laggard, but most of the recent stock price decline can be attributed, I think, to the currency decline brought about by Brexit.

The idea that a venerable British firm would fall into American hands, with layoffs following close behind, appears to have been more than #10 Downing Street could tolerate.

That attitude is probably also going to remain, meaning that weak management teams in the UK need not fear being replaced–and that Buffett will likely have to look elsewhere for his next conquest.