Technical Analysis vs. Fundamental Analysis

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Durable goods orders 1-28-13Of the two main methodologies used to predict the future direction on
the price of a security, an index or even the economy, which is better-
Technical Analysis or Fundamental Analysis?  If I were forced to only
use one in my market analysis and security selection, technical analysis
would win hands down.  Fortunately, I’m free to use (and do use) both
TA & FA as both methodologies definitely have their pros and cons. 
Typically, fundamental analysis (FA) is used by those with longer-term
time frames such as investors or economists whereas TA has useful
applications in predicting both short-term price movements in securities
and markets as well as long-term trends.

When it comes to security selection (aka- “stock picking”), I give a
much higher weighting to TA over FA.  A recent example of this would be
AAPL, which was added as a short trade on the site on Aug 27th at 679.99, a
mere 3 1/2% & 3 1/2 weeks before the stock hit it’s all-time high (also right around the time our beloved Slope Miester, TK, started hammering the proverbial nail in AAPL's coffin)
Keep in mind at the time that the fundamentals, both current &
forward looking (according to the vast majority of analysts, pundits and
other misc. experts, most of whom use FA in formulating their opinion)
could not have been more bullish.  Of course, as the basis for the short
entry, the charts (TA) were clearly telling another, completely
different story on where the stock was likely headed.

Now let’s turn our attention to the macro-economic picture of the US
economy.  As I mentioned recently, there is most certainly a bullish
case to be made right now (or really just about at any time) with the US
stock market and although I could spend a little extra time in making a
case for both sides (longer-term bullish and the longer-term bearish
outlook for 2013), my preference for now remains to support the
longer-term bearish case.  Therefore, let’s take a quick look at some of
the fundamentals of the US economy while applying simple TA to those
charts.

As I look at the economic calendar (link located under “Tools of the
Trade” on the right-hand sidebar of RSOTC.com), I can see that we have
several key economic reports scheduled to be released this week.  Let’s
take a quick look at those charts and the simple annotations that I made
to each one (trendlines, notes, etc..).  Several of these reports are
not accompanied by charts so will not be discussed and I’m only going to
show the charts that directly show economic activity.  This would
exclude charts such as consumer confidence (which is a coincident
indicator at best, and therefore useless IMO); housing (while home
values have an effect on consumer confidence and the ‘wealth effect’,
this is not a direct measure of the growth or contraction in the economy
such as GDP or the various manufacturing indexes); jobless claims
(which is widely acknowledged that when you hit such a high unemployment
level as we have, there is pretty much but nowhere but down for the NEW
claims number to trend plus, not a measure of expansion or contraction
in the economy per se).

That brings us to those key reports due out this week, starting with
the Durable Goods Orders that was released at 8:30am ET today (first
chart below).  By adding trendlines (TA) to these economic charts (FA)
we can see that the rate of growth in the US economy has clearly been
slowing (i.e.-trending lower) for at least the last two years and many
of these key measures have now fallen to at or near levels not seen
since the beginning of the Great Recession and start of the bear market
in late 2007.  Something that I point out on today’s Durable Goods
Orders report are the aberrations, like today’s “bullish” reading of
+4.6% vs. the consensus of on +1.6%.  Bullish?  Well certainly…. if that
trend continues.  However, the reason that this chart shows the yearly
average (blue line) along with the month to month reading (grey bars) is
to smooth out the aberrations.  In effect, this is no different than
using moving averages on a stock chart to help tune out the day to day,
week to week, or month to month price swings and therefore help in
identifying the overall trend of the stock.  As you can see on this
Durable Goods chart, that important measure of economic activity has
been in a clear downtrend (channel) for over 2 1/2 years now and is
flirting with contraction territory.

The remainder of the charts are self-explanatory and once again, are
due to be updated later this week.  Downtrends don’t remain in place
indefinitely and therefore I will continue to monitor the trends in
these important economic indicators for signs of reversal.  Just like
charting an individual security or index, once a multi-year downtrend
line is broken to the upside the odds sharply increase that a new
uptrend may have begun.  I would image that if this were to happen on
these economic indicators soon, the stock market will have likely put
the current key overhead resistance levels and longer-term divergences
comfortably in the rear-view mirror and as such, look more bullish from
both a technical and fundamental perspective.  Until then, a potentially
dangerous disconnect between rising equity prices against a back-drop
of deteriorating economic fundamentals continues to build.


GDP thru 12-20-12
Chicago PMI 12-28-12
Markit PMI 1-2-13
ISM Manufacturing Composite Index-1-2-13

chart sources: ECONODAY

Additional chart annotations and commentary by Right Side of the Chart

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