The investment process is all about the future. When projecting ahead, investment professionals commit to a rule or a combination of rules which guides them to a buy (or sell) decision. The business outlook for a company usually leads an analyst to an earnings projection and a valuation analysis of whether a stock is undervalued (a buy) or overvalued (a sell).
Additionally, an analyst will likely do an analysis of the outlook for the particular sector or industry that a company operates in. If the outlook for the industry is positive, the analyst gets positive confirmation of the analysis done on the company.
A larger economic analysis can also be done to confirm the environment at large. Consumer attitudes and spending patterns are important in defining the economic outlook. The more information, the better. The process should include politics, getting a view of probable tax policies as well as government spending.
Lastly, global conflict and wars are always feared as they often disrupt the flow and pricing of critical commodities around the world. They also destroy markets rendering sales analysis useless.
These considerations are all fundamental in nature and are known as the fundamental side of the investment business.
When asked, “What’s the market going to do?” one must factor all the different considerations and determine the probability of each, and then aggregate these into one conclusion: up, down, or flat.
To add some complexity to the process, there are different securities markets to consider. The bond market is a totally different market with separate considerations. The outlook for bonds may be very different from the outlook for the stock market. At times, the fundamentals are clear, and an answer is easily rendered. Typically, fundamentals are mixed, but clearly leaning one way. Today most fundamentals are pointing downward, but we have become somewhat constructive on the equity market over the shorter term and on bonds for the longer term. Why? The technical picture has gotten more positive for stocks.
The technical side of Wall Street has evolved in order to give one a quick read on the market, or a stock or bond. In short, it’s an attempt to interpret market movement in order to project the future. The projections are based on expected investor emotion and behavior which have been studied for years. Price behavior, money flows, support prices as well as price resistances are all tracked and illustrated. The disciplined technician rarely considers changing fundamentals. Illustrating past investor actions is most important and interpreting these actions into future actions is the entire process for a technician. In fact, a technician is not interested in why an investment moved, but instead, where is it most likely to move next.
We have always included the technical picture in our investment process. Ideally, the technical picture is in harmony with the fundamentals which gives us strong confirmation of our investment outlook.
Presently, however, the market fundamentals are pointing lower. Our current value analysis tells us the stock market is overpriced. The economic, political, and global analyses are all negative. However, the technical picture of the market is becoming increasingly positive. In fact, the technical pictures for bonds, the currency, and commodities all seem to refute the fundamental analysis for each.
Why? We don’t know, but that question is not important to a technician. Accordingly, we are adding equities as the technical picture strengthens. We won’t “bet the farm” when things are this mixed, but we also won’t disrespect the technical picture of the market. In other words, we won’t fight the market.
The market strength started with a few stocks—mostly beneficiaries of the AI (artificial intelligence) boom. Actually, the positive technical picture was based on a very narrow base (a technical flaw) of these few stocks. The strength has broadened, and that has given it the credence we needed.
Our partial position in long term bonds will stay in place as the fundamental picture for bonds is pointing at a bull market to begin no later than next year. The technical picture is moderately negative but has not changed in months.
In summary, we are moderately bullish because of the strengthening technical position of stocks. Admittedly, this was not an easy conclusion to come to.
The global picture is also mixed up as China seems headed into a recession, although she aggressively strides around Taiwan. Russia now appears quite unstable as Putin’s hold on power seems to be weakening. The linkage between Russia and China is also not very clear, but we can assume the balance of power around the world has become more precarious.
The conditions around the world and in our markets set us up for a very necessary vigil. Our bullishness will require a close watch of the technical indicators. We will keep you posted as we proceed into the second half of the year.