In my last blog post of 2017, on December 28th, I talked about a series that runs every December on one of our major information sources called The 12 Days of Christmas. As I said in December, I will post one of these discussions monthly throughout 2018. All 12 are included in a video on our website. These monthly posts will provide a more in-depth discussion of tactical analysis and our investment process.
So, to pick up where we left off in December , there are two types of securities analysis - fundamental analysis and technical analysis.
Fundamental analysis is what most of us are familiar with. When you see an analyst on television or read comments from an analyst in a magazine or news story, most often these comments come from fundamental analysts. A fundamental analyst tries to answer the question of “what” to buy. He or she will study the company’s balance sheet, evaluate the management team, and try to understand the quality of the company’s earnings.
The Point & Figure methodology is a specific form of technical analysis. A technical analyst tries to answer the question “when” to buy and just as importantly, “when” to sell. A technical analyst wants to determine whether demand or supply is controlling a security’s price. Is the stock outperforming the broad market? How high, or in some cases, how low can the stock go?
Unfortunately, there are very few on Wall Street who effectively combine the fundamentals with the technicals. In a sense, they’re playing the piano with only one hand. While that may be a way to play a simple melody, you can play much better music if you play the piano with both hands. In fact, our game plan is grounded in this philosophy of combining the fundamentals with the technicals, or playing the piano with both hands.
This industry has historically been overrun with "Buy" recommendations and a scarcity of "Sell" recommendations, so the need for clear, objective ratings cannot be understated. According to FactSet, well over 90% of the current analysts’ ratings are either “Buy” or “Hold” for stocks in the S&P 500. In fact, as of 12/08/2017, 49% of stocks in the S&P 500 are rated a “Buy” and 46% are rated a “Hold” according to the analysts. Suffice it to say, 95% of the market can be bought or held according to these analysts, who are primarily all fundamentally oriented. Or to state it another way only 5% of the S&P 500 members are rated as “Sell.” The breakdown for sectors is displayed below, and in some cases, like Healthcare, only 3% of the entire sector is rated a “sell.”
Unfortunately, as we will discuss in a future "12 Days" post, the breakdown of analyst ratings was not that much different during the 2008-2009 bear market, which was the worst since the Great Depression!
Utilizing the point and figure methodology, we can offer an objective, disciplined approach that is grounded upon the basics of supply and demand. Our primary source for Point and Figure technology, Dorsey Wright, provides a technical attribute rating on more than 6,000 U.S. stocks, international stocks, mutual funds and ETFs. These ratings provide a clear-cut way to determine whether something is strong (a buy), or weak (a sell). Utilizing the technical attribute methodology, instead of only 5% of the S&P 500 being a “Sell” candidate based on analyst ratings, roughly 40% of the S&P 500 stocks are rated below a three and in low attribute territory. This means that there are around 200 stocks in the S&P 500 that technical analysis has identified as “Sell” candidates because they are currently being driven by supply.
To illustrate the point, let's look at Ford Motor Company (F). Most of us would acknowledge that Ford is a good company that makes good cars. However, even if you like their cars, their brand, and even their company, it doesn't mean you have to like their stock. In fact, if you have been following Ford stock or own it, you probably don't like it a whole lot! Since January, 2011, Ford has experienced its fair share of ups and downs; at times, Ford appears poised to “go” and trades higher, only to stop or stall and retrace its move. Since the beginning of 2011, Ford has fallen (-24.9%), while the S&P 500 has risen over 100%! During most of that time period, Ford has been rated below a three in technical attributes. Although Ford has been trending lower for the past couple years, it is still rated a "Hold" or a "Buy" by over 90% of fundamental analysts! According to Yahoo Finance, as of January 18, 2018, there are zero “Sell” ratings for Ford.
Whatever the reason turns out to be for falling stock prices, the bottom line for F was that there were simply more people selling the stock than buying the stock. It is this simple economic concept that drives not only the price of produce in the super market, but also the price of oil or silver on the commodity markets, Bitcoin in the crypto currency markets, and stocks on Wall Street: supply and demand. The Point & Figure chart does not care if the stock underlies a good company or not. There is no preconceived bias, and there is no emotion in the Point & Figure chart. It is only concerned with the price action of the stock in order to record imbalances of supply and demand.
As most of my readers are aware, our focus is mainly on indexed funds called ETFs. The technical tools illustrated above assist us in implementing our investment philosophy of overweighting strong sectors of the market, underweighting weak sectors, and avoiding bear markets as much as possible.
Until next time, cheers!
Jim