Stocks and bonds.
(photo credit: Profile Investment Services)
A few of us were sitting in the succa the other day, discussing investing. Haim
(not his real name) was telling us that he had finally determined to make an
effort to understand the world of investments, and had therefore decided to sign
up for one of the courses on the subject that are advertised in the media.
However, in making a few phone calls to elicit information, “I discovered that
they all use intensely aggressive marketing to get you to sign up with them,
which really turned me off.”
It will be readily apparent that Haim is not
a sucker and he turned his back on what he realized was an intensely
commercialized field, which meant that the companies in it were primarily
engaged in selling a product than in making him more knowledgeable. Instead, he
found a private individual, knowledgeable and experienced, who offered to teach
investment analysis – effectively, corporate research and how to apply it – to
small groups, for reasonable sums and with no “agenda” of his own. Haim said
that he enjoyed these sessions very much and had learned a great deal from them
– to the point that he was able to sift through companies and make his own
decisions as to whether they were worth investing in.
David, on the other
hand, took a different approach.
He explained why he prefers to use
technical analysis, at least in combination with fundamental research, if not as
a full replacement. So far, so good. This is an old, but still vibrant and
essential debate about how to learn about investment theory and which approaches
to adopt, when and what are the relative advantages and disadvantages of
However, whereas in “the old days” – meaning before 2007-09 – I
would have been an enthusiastic participant in this kind of debate, I found
myself pouring cold water on Haim’s enthusiastic embrace of fundamental
And whereas in the old days, I would have used the parameters
of fundamental versus technical analysis, now I found it unnecessary to relate
to technicals at all.
The problem with fundamental analysis is the
problem with the markets as a whole today, namely that they have ceased to
function in the way they are designed.
Markets, especially securities
markets, are no longer sophisticated mechanisms for price discovery – meaning
that the prices generated by the activity in the markets is no longer a true and
fair reflection of the value of the security being traded, whether it is a share
or a bond.
The cause of this systemic dysfunction is, of course, the
massive and ongoing distortion being applied to the markets by the world’s main
central banks – those of the US, the Eurozone, Japan, the UK and, last but
certainly not least, China. By pumping into their financial systems huge amounts
of money for a period exceeding five years, the central banks have prevented the
markets from finding their “true” levels and have instead created a bubble in
The size and scale of this bubble is a matter of intense
debate, but its existence is admitted by almost everyone.
The remarks of
Andrew Haldane, a senior Bank of England official, were quoted in this column a
few months ago, but more recent remarks by members of the Federal Reserve’s
Board of Governor’s have left no room for doubt that they, too, see the markets
as distorted by their policies – and they are openly arguing among themselves as
to whether this distortion and the damage it does is still justified, as well as
whether and when it will be possible to reverse these policies. The
extraordinary reversal of the Fed from its promises to begin “tapering,” to its
decision last week not to do so, are symptomatic of the extent of the growing
problem in “policy-making circles.”
But coming back to fundamental
analysis, the reason why it is not a serviceable technique is because the prices
for securities in the market no longer reflect, or relate in any way, to the
fundamentals of the company underlying those securities. In more theoretical
terms, the basic tool of fundamental analysis is the discounted future cash flow
of the company being analyzed. The discounting is done on the basis of the
“risk-free” rate of interest in the economy – in the US, that means the rate of
interest on Treasury bills. But if that rate of interest is openly and
officially distorted, for years on end, and with no clear idea of when the
distortion will end, then the discounting mechanism becomes meaningless and its
results are even more so.
The stock market, and indeed the entire
financial system, have been reduced to “garbage in, garbage out,” and no
sensible investment conclusions can be drawn from