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My friend Tom Peterson wrote this. It is worth reading when you can focus on
the content.
-----Original Message-----
From: T R P <trader8@xxxxxxxxx>
To: Neal Weintraub <thevindicator@xxxxxxxxxxx>
Date: Thursday, October 08, 1998 1:16 PM
Rocket Science, The Tower of Babel and Golf
Almost since the first day market securities have been traded, investment
professionals have attempted using sophisticated analysis to try to
understand trading relationships between price, volume and time in an
effort to gain an edge. Despite the fact that many great fortunes have been
made by so-called "technical analysis" practitioners, it is still widely
considered today by uneducated investors that technical analysis doesn't
"work". That is to say that prevailing propaganda maintains that investors
cannot use technical analysis to consistently make money. If there is one
style of analysis that works in most market environments, it would be
technical analysis, but technical analysis needs fundamental analysis in
order to work properly. The best market traders have all been "tape
readers" of one sort or another. That is because exceptional professional
investors constantly look for evidence that their investment scenario is
right. They use a combination of fundamental analysis for the long-term
overview and technical analysis for timing. Professionals know they are
wrong when they start losing money. That's why they keep their losses
small, because they look for their trades to behave as expected, and when
they don't, they know that they have to at least step back and re-assess
their outlook. Rigid thinkers only thrive in trending markets. Flexible
thinkers make money in all markets.
The Market Technician's Association has recently taken steps to try to earn
increased investment industry respect. In July 1998 the Market Technician's
Assoc. was kind enough to publish an article I wrote wherein I advocated
that technicians should not take it upon themselves to convert all the
non-believers to the t.a. brand of analysis. I believe it is enough proof
that one consistently makes money, and that since t.a. provides an investor
a great tool, it is to one's advantage that only an educated minority
practice it. I have even gone so far as to offer proof that using
fundamental analysis in isolation doesn't "work". One need only to pick up
any daily newspaper to find sobering reports of fundamental analysts caught
dead wrong when their favorite stock gets clobbered for huge losses. In
almost every case of the Cendant, Sunbeam, Northern Telecom, Case, Cummins,
Caribiner, Newcourt Credit, Bre-X, Peoplesoft, Revlon, etc., ad nauseum
debacles there have been clear technical "sell" signals well in advance of
the slaughter. These are all cases where the senior executives of the
companies have been publicized assuring nervous investors that there was no
need to worry as the stocks continued to fall, some as much as 70% and
more. For another example, on July 11, 1998 I provided a list of 46 sell
candidates to my clients using one of my favorite signals, and of the 46
only one stock went higher than the stop price. Of the rest, three went
sideways and 42 were significantly lower only days later. Regarding the
current mark down phase in the capital markets, many technicians, myself
included, had warned people that this year would look like 1987. In fact,
as early as in my Feb.8, 1998 forecast I used the 1987 parallel and stated
the DJIA 9400 level as our primary target. A very few analysts, including
esteemed colleague Frank Teixeira (and I), went completely bearish this
past July, warning that the markets were going much lower soon. So, there
is tremendous proof that not only does technical analysis "work", but that
it works better than isolated fundamental analysis in that it will better
enable investors to make, and keep, their money. It is just much more
difficult to apply, and in my view that is further proof that it is more
worthy of credibility than its weaker cousin, fundamental analysis. In the
MTA article I wrote, "After all, any accounting student can pull apart a
balance sheet, or take management's word on future earnings."
The credo of long-term investing is the refuge of the one-eyed analyst, who
can only see bull markets, and
preaches the mantra of "buy and hold". This is the market equivalent of
driving down the road, running over the "detour" signs, but driving
straight ahead anyway in the belief that sooner or later the road will get
better. Along the way, the potholes may take out your tires, and your car
will get damaged, but you still drive blindly on hoping (expecting) the
rest of the convoy to follow you. Why wouldn't you take the detour and
drive around the potholes? Because most drivers don't realize where they
are on the map, they are too stubborn to back up when they find out they're
in trouble, and besides "in the long run" things always work out, assuming
you haven't crashed in the meantime. The financial markets, as everyone
knows, have longer bull periods than bear periods. Whether your portfolio
(or your nerve) survives the bear is a different matter. A balanced
approach employing fundamental and technical analysis works best.
Much has been made recently about the failure of Long Term Capital
Management (LTCM) and their particular brand of "rocket science" and
rightly so. One of their lenders, UBS Bank, has written off $700 million
from LTCM losses and fired a bunch of senior executives responsible. That
is just the tip of the iceberg, of course. The LTCM fiasco is very
reminiscent of the Olympia and York bank debacle of the early 1990's. In
both cases, it was deemed by bankers to be poor manners to ask the
borrowing party to produce financial statements before lending (investing)
huge amounts in their enterprises! Isn't it amazing how the banks make the
same mistakes repeatedly? This has something to do with the worship of
academics in our culture. Studies with actual money in real-time (as
opposed to back testing), have shown that there is an inverse correlation
between making consistent money in the market and the degree of
complication in your investment approach. Many bankers, who have a passion
for numbers, fall in love with the idea that if they just crunch the
numbers enough, they can get an edge. This allows for increasingly
complicated houses of cards like LTCM. They are based on a weak foundation.
As I understand it, the hedge funds like LTCM try to capture the difference
in spreads between debt instruments of different countries as one of their
strategies. In my October 19, 1997 forecast "Whistling Past The Graveyard",
I mentioned that one technical indicator called the "Ted Spread" (the
spread in interest rates between T-Bills and Eurodollars), had widened to
95 points, and that normally a spread of 85 points would be a warning sign
to the markets. Historically, the Ted Spread has been a measure of Global
risk, because Eurodollars are uninsured, whereas Treasury Bills are very
safe. Well, using this analogy, it stands to reason that since hedge funds
like LTCM are trying to capture what they think are inordinately wide
spreads between issuers of different quality, they are doing what no
professional trader should do, and therefore it is not surprising that they
should get burned. Put another way, they are "fading" a warning sign! They
are trying to put their market opinion above that of the market. This is a
form of market arrogance, and the practitioners of arrogance usually have
to learn humility eventually.
Only the top bankers in the world know how many other financial
institutions have built up similar "Towers of Babel". It is very sobering
to think that the decimation of financial service stocks, where many have
lost 50-60% of their value in only a few weeks, is a reflection of the
beginning of understanding of the risk in this area. That these stocks have
sunk so low on relatively modest announcements makes one wonder how bad the
news will get. In my humble opinion, the complicated "hedge" strategies
practiced by these so-called hedge funds can only out-perform for short
periods of time, and over the long-term the investment risk actually
increases. With the proper application of technical tools, an
intermediate-term investment approach will out-perform every time,
especially because avoiding market downdraft periods will allow the
investor to maintain hard-earned profits from bull markets. One of the main
tricks is in identifying when a secular change has occurred, as in this
past July 1998, as opposed to just a minor correction within an uptrending
market. The investment performance of the firm of Di Biasio and Edgington
(D & E) based in Virginia has illustrated proof that an intermediate-term
balanced approach is superior. D & E is a firm of professionals who
throughout the years have catalogued a number of technically-based tools
signaling intermediate to long-term trend changes and built them into a
computer program. Their approach is now part of their popular system called
"INSYNC" utilized by many top-performing portfolio management firms in the
country, several of whom produced 15% plus gains in the third quarter with
less volatility than the average "buy and hold" fund while the major
indexes went negative. [It is, in my opinion, a type of investment secret
weapon, but it requires a trained analyst. It is not a "black box".] This
is the type of sophisticated analysis approach that consistently makes
superior returns, without undertaking the undue risk of many of these
"rocket science" strategies. Investing should be less like rocket science
and more like golf – in the end, it doesn't matter how you get there, all
that matters is how you score.
T.R. Peterson October 7, 1998
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