Focus on making fact-based decisions, well grounded in the fundamental, valuation and technical data and analysis when making investment decisions.
Jun. 7, 2018 Commentary

Benefits Of Technical Analysis: A More Complete Picture


“The biggest big business in America is not steel, automobiles, or television. It is the manufacture, refinement, and distribution of anxiety.” - Eric Sevareid, 1964

The above quote made by the well-known journalist, Eric Sevareid, was an observation he directed, ironically, at the industry he selected as his career-long focus and in which he excelled. We agree with his journalistic warning. Interestingly, he made this statement in a time when “the news” consisted of merely the daily newspaper and the evening news report on a local TV affiliate station. This was well before the “fake news” reports we hear about in social media today.

The key point he highlights is that headlines, regardless of era, have great capacity to spread fear and emotions.  They may sell newspapers and generate active users, but they can result in significant opportunity costs for investors as well as severe regret for listening and acting upon them. This is the very reason you hear us focus on making fact-based decisions, well grounded in the fundamental, valuation and technical data and analysis we conduct.

Now you’ve heard us talk quite often about the fundamental and valuation work we do and why we think they support a continued advance in stocks…strong economy, low inflation, accelerating earnings with regard to the former and reasonable price-to-earnings ratios in the case of the latter. And this fundamental and valuation work probably encompasses 75-80 percent of the analytical work we do. That said, looking at the technical aspect, particularly at inflection points — at potential bottoms and tops for the stock market or for asset classes or for individual stocks — helps provide the necessary conviction to stay the course and make tactical adjustments when appropriate. Studying the fundamental, valuation and technical analysis provides a more comprehensive view and mosaic of the investment case at any point in time. Currently, the technical price trend data and associated investment sentiment indicators are quite productive for a continuation of the bull market. Of the 10 key signals we look at to call a top in the market, none of them are signaling a top at present. If they were, we would be singing a different tune and maybe a little more in line with the tenor of the pessimistic headlines.

What are the Technicals Telling Us?

In terms of quick backdrop, I can recall first learning about technical analysis back in the 1980’s and attending a conference on the subject that was led by a legend in this arena—Ralph Acampora. Ralph is a long-term market technician and formerly one of the christened “elves” that Louis Rukeyser featured on his show, Wall Street Week, back in the days before CNBC and financial news, 24/7. I realize I am dating myself here.

Ralph told a story at the conference that I will never forget. He discussed the training that military pilots undergo to allow them to maintain focus and concentration when flying at supersonic speeds under combat conditions.  Instead of worrying about the life and death situation at hand, they are trained to stay glued to the data on the control panel no matter the conditions and stress levels. By focusing only on the metrics on the dash, which give them a clear picture of where enemy fire is coming from and at what speeds, they are able to execute the toughest decisions effectively and without emotion.

Perhaps a little dramatic, but Ralph’s point in drawing the analogy to technical analysis is that a picture can be worth a thousand words and that focusing on the graph or the key metric at hand can keep one engaged in the facts when all the crazy headlines we are bombarded with can clog our minds. Some believe meditation is a great way to cleanse the mind and keep it open to healthy function; technical analysis does that for us…but, perhaps meditation wouldn’t hurt as well!

Truthfully, the skeptics have had the upper hand/loudest voice ever since the bull market began back in March 2009. The wall of worry items in the headlines back then were exhaustive. In 2009, reasons not to invest, per the news included:

  • The American consumer is in a cave and will be deleveraging forever; they will never spend again
  • Companies are doing better because of cost cuts; revenue growth still looks horrible
  • Bank stress tests and tighter regulation will choke the financial industry for years
  • Higher taxes and fiscal debt will derail the recovery in short order

I could go on about the reasons cited not to invest in 2009, right before the 300+ percent, nine-year advance in the market, but this should be sufficient. From a fundamental standpoint, things first got less worse, then stable, then pretty good. They began to inflect positively in slow fashion and this is exactly how recoveries evolve; valuation was cheap. But the technicals started to turn nicely at that point and have continued to remain constructive throughout. They provided needed conviction to regain confidence in stocks at that moment.

There were some mild wobbles from time-to-time in the technicals in the 2009-2018 timeframe, but never a breakdown or suggestion of a market top over this entire time period. They have helped to keep us engaged in equities with confidence throughout this stretch. Yet, the headlines have been ugly throughout, hence contributing to the phrase that this has been the most disrespected multi-year market advance on record. Headlines continued to focus on the negative…in 2011 and 2012, they focused on the Arab Spring and government shutdown. In 2013, it was fiscal cliff and the Federal Reserve induced taper tantrum. In 2014, it was fear that plunging oil prices were signaling looming global recession. In 2015, it was China’s economy that was falling off a cliff…we’re still waiting.  And then in January 2016, the continued decline in oil prices. This time many folks thought we were nearing a recession, right? If oil prices aren’t an indicator, then the June 2016 Brexit vote must spark the global decline we’re anticipating, so the headlines read. Not? Well then let’s go with the headline, “Trump Victory in Presidential Election Will Cause Stock Market Crash”. Today the issues center around tariffs and trade, concerns over mid-term elections and political leadership in Italy. They show no signs of letting-up. The point is, all of these breaking news items can clutter the mind while the technical data can keep you sane…and appropriately invested.

What Specific Technical Factors Do We Key-On?

We look at three technical factors…breadth, momentum and sentiment. We like to use a basketball analogy to explain a key benefit of conducting technical analysis at the market level. An NCAA March madness contender may be in the tournament and have an impressive record with 20+ wins in the season. But, if many of those wins were at home versus away, against weaker teams and by narrow margins, that doesn’t provide nearly the confidence as does a team that has defeated highly-ranked opponents on the road by wide margins. While the records of these two teams are similar, the underlying performance stats prove the latter to be stronger; that team should enjoy a deeper run in the tournament.

Similarly, we like to use technical measures to help identify if the market advance is high quality in nature, or more suspect and vulnerable to near-term failure. Based upon the technicals we monitor closely, we believe this advance falls in the former category. For more understanding, let’s tackle each of the three types of technical measures we follow sequentially in efficient fashion:

  • Breadth: Tells you how broad the market is. If the advance is being led by just a narrow list of only the largest companies, rather than a broad list of names, this is a concern. A good way to measure this is to examine the number of stocks advancing versus the number of stocks declining. The adjacent chart reflects good news on this front…the so-called advance-decline line is close to all-time highs since 2010, meaning the ratio of advancing to declining stocks is trending at healthy levels. Back at prior market tops, such as 2000 and 2007, the advance decline line rolled over in advance of these major declines.

S&P 500 Advance-Decline Line

  • Trend and momentum: With trends, we look at such things as moving averages and long-term trend lines. As the saying goes…the trend is your friend. As long as it continues, it should be respected, just as it should be respected when the long-term uptrend or downtrend has been broken. On that score, the current long term price uptrend of the stock market is unbroken and remains in-tact. Furthermore, the other great lesson with regard to the direction of trend lines is that they tend to last longer than one can imagine. Certainly, the duration of this positively trending nine-year bull market in stocks pales in comparison to the long-term trend lines that have occurred in interest rates. This includes the 37-year downtrend or consistent decline in interest rates that began in 1981 and that may just now be ending. It’s just now reversing 40 years later? Perhaps, but it hasn’t turned up yet and many careers have been ruined trying to predict the end of that one. Ironically, this downtrend was preceded by the 35-year uptrend in interest rates that started in 1946 and ran all the way through the beginning of 1981. The punch line is that trends can last a long time and age alone is not reason to believe it must end…we look at the chart to capture the breaks, when they occur. Again, the 9-year uptrend in the S&P 500 appears to remain in place in reviewing the chart.

    Not only do we examine the trend of the overall stock market and stock market sectors to see if they remain in price uptrends, we also do the same when looking at individual stocks. The objective is to hold a stock as long as the trend is rising if confirmed by solid fundamentals and valuation that remains reasonable to attractive. Interestingly, by observing individual stock price trends, we can gauge how the entire market is truly looking; after all, the market is merely the aggregate of the individual stock trends. At points of inflection, this exercise is very helpful. For example in 2007, although the market was making new highs early in the year, the price charts of many individual stocks were breaking down and showing weak trend; this is an example of negative divergence. Similarly, in early 2009 when the market recovery began, the Standard & Poor’s 500  index was hitting new lows while many individual stocks were actually looking like their trends were beginning to turn up…this is known as positive divergence. Negative divergence is a warning sign and positive divergence is an opportunity.

    Another way to capture divergence is by looking at market momentum, for example the percentage of stocks above their 50 and 200 day moving average. When these percentages are at healthy levels and rising, that is an expression of solid price momentum in the market. Momentum measures such as this can also bring to attention negative or positive divergence. When the market makes a new high but these momentum indicators don’t confirm the high via a healthy reading as well, this is negative divergence and does give a warning for a forthcoming decline. Both of these measures are in neutral territory today and in decent trend. Further, most stocks remain in positive longer-term uptrends, which suggests generally healthy conditions will continue.

Percentage of Stocks in an Uptrend

  • Sentiment: There are several indicators we look at on this front:

    • The first is straightforward…the number of bullish investors versus the number of bears. One survey that captures this is the Investors Intelligence Advisors Sentiment Bull and Bears measures. Oddly enough, with this indicator, the theory is that when most advisors are bearish, you want to be bullish (particularly if the fundamentals and valuation are on solid footing as well). Of course, they’re not asking us! According to Investors Intelligence, the percentage of bulls has fallen from 65+ percent earlier in the year down to below the 50 percent level. It remains below frothy levels at euphoric market tops.

    • Flows into Equities - Actually, and to the point, I rephrase and say: Flows out of Equities. Cumulative flows into equities have continued to be negative throughout the nine year bull advance, including in 2018. Investors have purchased almost $2 trillion in bonds since 2009, but have been net sellers of stocks in that time period to the tune of $250 billion. This is extremely rare, and is a positive sign as a contrarian indicator. Generally at market tops, retail investors are storming into equities and when things implode, there just aren’t any incremental buyers to be found…far from the case today!

    Net flows into Equity and Bond Funds

    Source: Strategas

    • Leadership - Normally when fear gathers and we are at market tops, it is rare to see higher beta, more cyclical and smaller cap stocks lead as they are today. We would expect to see a shift to more defensive names such as staples, utilities and telecom as market leaders. Currently, these defensive groups represent the biggest laggards.

  • Other - It’s worth a mention that we follow other indicators such as credit spreads, IPO issuance, etc. Signs of a market top on these metrics are also absent.


In closing, another insightful quote from Eric Sevareid is: “Better to trust the man or woman who is frequently in error, than the one who is never in doubt.” 

Believe me, we maintain healthy, but constant paranoia about the Wall of Worry…we’re always looking for signs that our current investment thesis could be wrong or in error. We use all three lenses…fundamental, valuation and technical analysis to check our thinking and minimize any potential error. We consistently strive to listen to the data and what the market is trying to tell us rather than foolishly tell it what it should do. Thanks for your ongoing confidence and the privilege to serve you.


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