I decided to write this piece because of a short post at Alea; rather than comment there, I thought I would post something slightly longer here.? Consider the similarities between the US and Britain in the current crisis:
Accommodative monetary policies.
Generally free-ish with respect to financial regulation and credit.
Overleveraged housing markets after a bubble.
Banks that felt they could hedge risks and enhance returns through structured finance and derivatives.
Aggressive approaches to bail out financial institutions.
There’s probably more, but now I want to highlight one difference: the US Dollar is the global reserve currency and the British Pound is not.? Thus Britain, as it tries to reflate, runs up against borrowing constraints faster than the US does.? Those limits aren’t showing up in their interest rates yet, but it is showing up in the currency, which has been falling rapidly of late.
With the creation of so much liquidity out of thin air, the surprise is not that the British Pound is weak, but that the US Dollar is strong, and still regarded as a safe haven.? Then again, what are the alternatives?
The Yen?? Japan has its own problems, and their economy is not large enough to deal with all of the financial flows entailed.
The Yuan? Banking system too immature.
The Euro? Too young.? Tha current danger of the Euro is not that it will be weak, but that it might be too strong, leading to hard adjustments in Ireland, Spain, Greece, Portugal, and tangential European economies with weak fiscal policy positions.? I’ve said it before; I’ll say it again: the Euro is a noble experiment, but currency unions that are not political unions don’t typically work.? Then again, most fiat currencies eventually fail.
External commodity-based currencies?? None that I know of; few governments want to limit their power by tying their hands on monetary policy.
That leaves the imperfect US Dollar.? For now, lending to the US remains open, despite the many problems, and the paltry compensation for lending to the US Government and those that they guarantee to varying degrees.
If you live in the US, it’s a small reason for optimism that we don’t deserve, but it allows our government to borrow more.? Now, whether they will use it wisely is dubious, but things could be worse.? Ask Britain.
Since 1996, I’ve been aware of research that indicates that momentum works in the stock market.? My quandry as a value investor has been to figure out how to incorporate it, if at all.? My approach was to play for the weaker mean-reversion effect, and have a lower turnover rate than would be needed in a value plus momentum strategy.? I am now questioning that decision, even though I have done well in the past. I just finished the initial stages of an analysis that will be available to my clients highlighting the value of momentum strategies.? Using the industries in the S&P 1500 Supercomposite, from October 1995 to December 2008, investing in the Supercomposite yielded an annualized price return of 4.0% (with dividends 5.5%).? The annualized price return for each momentum quintile, where momentum was defined as return over the previous 200 business days, was as follows:
Top — 11.3%
Second — 4.4%
Middle — 6.5%
Fourth — 1.7%
Bottom — 0.2%
Now, there are several weaknesses with this analysis:
No trading costs.? (I think those could be minimized.)
Some industry groups are small, and could not accommodate a lot of money.? (Probably a large problem)
That said, even with those difficulties, there should still be some excess return from following a momentum strategy.? What industries would that imply at present?
Education Services
Brewers
Biotechnology
Water Utilities
Insurance Brokers
Environmental and Facilities Services
Hypermarkets & Supercenters
Health Care Services
Packaged Foods
Pharmaceuticals
Gold
Multi-Utilities
Restaurants
Tobacco
Household Products
Home Improvement Retail
Food Distributors
Distillers & Vintners
Reinsurance
Food Retail
Integrated Oil & Gas
Health Care Technology
Airlines
Health Care Supplies
Electric Utilities
Distributors
For a quick summary, think staples, utilities, health care (excluding insurance), and other industries with stable cash flow.? This is about as bearish as it gets, so be careful for now, and don’t speculate on when the turn in the economy will come.? Focus on what consumers always need. Or, as James Grant once said (something like), “Could this be a bull market in cash?” 😉
I’m not against technical analysis per se, at least not anymore.? I don’t think I understand it well, but after reading The Heretics of Finance, I’m not sure anyone really does.? Let me explain.
When I wrote for RealMoney, I often thought it was two sites in one.? Technical analysts on one side, and Fundamental analysts on the other.? Little interaction, except to snipe at each other every now and then.? I’m happy to say that I stayed above the fray, because as a corporate bond manager, technical analysis helped me manage market risk better.? I wasn’t sure how to apply it to equities, though, particularly post-decimalization.
I posted something like this three times on RealMoney, and aside from one private response from Helene Meisler, no one ever bit on my questions regarding technical analysis:
I received some e-mails from readers asking me to post the questions that I mentioned in the CC after the close of business yesterday. Again, I’m not trying to start an argument between fundies and techies. I just want to hear the opinions of the technicians. Anyway, here goes:
1) Is there one overarching theory of technical analysis that all of the popular methods are applications of, or are there many differing forms of technical analysis that compete against each other for validity (and hopefully, profits)? If there is one overarching method, who has expressed it best? (What book do I buy to learn the theory?)
2) In quantitative investing circles, it is well known (and Eddy has written about it recently for us) that momentum works in the short run, and is often one of the most powerful return anomalies in the market. Is being a good technician just another way of trying to decide when to jump onto assets with positive price momentum for short periods of time? Can I equate technical analysis with buying momentum?
To any of you that answer, I thank you. If we get enough answers, maybe the editors will want to do a 360.
Position: none
That’s where I’m coming from.? In The Heretics of Finance, I received half an answer to my first question, and no answer to my second question.? Now, I enjoyed the book a great deal; it is well-designed.? The book begins by interviewing thirteen well-known technical analysts:
The next seven chapters ask all of the interviewees the same questions, allowing them to agree or disagree with each other.? The questions were asked to each person separately, in interviews from 2004-2005.? It would have been more interesting to have them all in one room, so that they could debate more, and question each other.
That said, many of the questions were interesting:
Does lack of academic support bother you?
Can TA be learned from books, or only through experience?
Are there universally valid TA rules?
Is it an art or a science?
How big of a role does luck play?
Do those that incorporate astrology into TA harm the discipline?
How much can TA be mechanized?
In the introduction, the authors, Lo and Hasanhodzic saw increasing acceptance of TA by academics, sometimes directly (challenging the weak form of the efficient markets hypothesis), or via behavioral finance (how value investors do TA).
There was no answer to my second question, as to whether TA is just a way of implementing a momentum strategy.? Surprising to me, Lo and Hasanhodzic did not think to ask the question.? (My opinion: aside from a few technicians that like to try turning points, yes, TA is a way to implement momentum investing.)
Who Would Benefit from this Book
If you want a taste of a wide number of accomplished technicians, this book will give you that.? It wilol also give you jumping-off points into TA literature and TA-friendly academic work describing Technical Analysis.? If you are into some of the main characters in TA, this tells their stories, and elucidates the attitudes of disciplined appliers of TA.
PS — Not many book reviewers read the books that they review.? They read the summary that the PR flacks send, and rely heavily on that.? I throw away those summaries, and read the books.? That takes time, but I like reading books, and when I wrote for RealMoney, I often missed reading books.? Now I read them more, and you can benefit from that, because I don’t always endorse the books that I review.
I don’t have a tip jar, but if you buy anything through Amazon, after entering through a link on my site, I get a small commission, and your costs don’t go up.? I like taking? the fees out of Amazon, and not out of my readers.
, and 
to a lesser extent, as definitive (and large) reference books on TA that give what they think is the overarching theory.? So, maybe I have an answer to my first question, but I’ll have to buy the books to understand it.
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