A (very) personal guide to an investment portfolio (Part Two)

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“To be objective we also need to do a critique of the stock market fundamentalist.

Reflecting on my article last week, I felt that it would be remiss on my part not to talk about another tool which is also extensively utilized by stock market analysts — professional investors and traders. My fault lies in the fact that it is a tool that I personally am not into and perhaps because in all candor, I find difficult to appreciate compared with the cold logic of looking at the historical performance of a company and the external factors that contributed to its performance and trying to forecast how the company would perform going forward based on assumptions culled from the past and expectations of the future.

Technical Analysis
The tool that I refer to is technical analysis. In the 9th edition of the book Technical Analysis of Stock Trends written by Edwards and Magee, apparently the bible of chartists, technical analysis refers to the “study of the action of the market itself” and is the ”science of recording, usually in graphic form, the actual history of trading (price changes, volume of transactions, etc.) in a certain stock or in the “Averages” and then deducing from that pictured history the probable “future trend.” The book further states that “prices move in trends and tend to continue until something happens to change the supply-demand balance.” Furthermore, “…such changes are usually detectable in the action of the market itself. Certain patterns or formations…appear on the charts which have a meaning and can be interpreted in terms of probable future trend development.” Whew! That’s a mouthful of words especially for simple investors like yours truly trying to make sense of how to invest with some rhyme and reason that is easy to understand. But the bottomline, what it all means is that the chartist will try to predict the price movement of a particular stock based on the patterns and trends observed over a long period of time. It’s very much like the now statistics-driven orientation of coaches and sports analysts when trying to select draft picks from the incoming basketball season draft pool or predicting who will likely be the next NBA champion.

Fundamental Analysis
To be objective we also need to do a critique of the stock market fundamentalist. The fundamentalist relies primarily on statistics. The process entails the close review of financial statements which is the sum total of the company’s performance for a given period of time. It requires an analysis of the market situation for its products or services, the competition it faces, its production capacity, the supply-demand picture of its raw materials, its solvency and its ability to raise financing to fund its expansion, the regulatory environment and, perhaps above all, the business philosophy of its principals and competence of its management. After a close review of these different factors, assumptions will then be made and through a sensitivity analysis, the fundamentalist will attempt to forecast the different probable outcome of the company’s future financial performance.

Using the common market metric of price-earnings multiple, various possible market prices will then be generated that could serve guides for future buy or sell signals. The chartists on the other hand argue that this approach relies heavily on the past which could already be out of date compared with the market price of the stock that reflects the totality of the market’s appreciation of the past as well as the future. Moreover with a myriad of factors for a fundamentalist to consider compared with the chartist that just requires a single step, predicting the company’s future performance will be a “…process built on quicksand,” according to Robert Prechter, publisher of “The Elliott Wave Theory” that chartists swear by.

What to do?
Both approaches have their merits as well as shortcomings and it really is up to you to make your personal choice. As I have already earlier declared, I have very much a fundamentalist orientation although I would at times try to have a sense of the stock market’s trends to guide my decision making. A crude approach to trends that I use is to look at the calendar. August is generally referred to as the ghost month by our Filipino-Chinese brothers and that typically suggests a no-no for any decision involving investments. December is also when there is a Santa Claus rally when the stock market perks up because of the jovial mood of investors, particularly by year’s end when institutions trade up the values of their stock position. January is when the institutional investors start loading up their position for the next year’s budget cycle. Tax payment month which falls on April could also experience some selling pressure, thus depressing prices. And May is when foreign portfolio managers typically go for their summer vacations, thus staying away from the market.

Until next week again…One big fight!

For any comments or questions, you can reach me at bing_matoto@yahoo.com.

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