ZF Capital

IN ECONOMICS CLASSES across the country, just about every curriculum starts and ends with fundamental analysis, the process of determining a company’s investment potential by analyzing its financial statements. It’s been that way ever since Chester A. Arthur was in the White House. After making assumptions on everything from interest rates to sales, inflation to the tax code, students construct models that help to determine a historically “fair” price for a particular security. Undervalued stocks are purchased; overvalued stocks are sold or avoided.

While fundamental analysis might succeed as an academic exercise, as a legitimate investment tool I believe it falls flat. Besides the fact that evaluating a company’s operations, management, competition, technology and regulatory landscape is nothing less than a full-time job, the implicit premise of fundamental analysis hinges on the assumption that a company’s economic condition will ultimately be reflected in its stock price. Yet as we’ve seen time and time again, a company and a stock are two separate animals altogether.

And because it’s the price, not the balance sheet, that we trade, technical analysis offers a significantly more useful method of evaluating markets. The basic premise of technical analysis is that the markets, like most things in nature, tend to move in trends that persist over time. So while fundamental analysis is rooted in often arbitrary assumptions and expectations, a technical approach correctly prescribes that we observe the market as it is, not as we wish it would be. (more…)