Consider some of the feel-good subjective components that have adulterated each approach:
- Fundamental analysis: any valuation based on growth estimates is suspect. And you don’t need us to remind you of the dismal record of bright young sell-side analysts when it comes to pricing stocks. Picking strong companies with stable earnings trading at a huge discount to book is a good idea, but that will always be a crowded trade.
- Technical analysis: many technicians deserve the bad reputation they’ve earned by conjuring a few too many head and shoulders patterns and bull flags. Technical analysis tends to be the most controversial school precisely because the occasional analytic insight tends to be accompanied by so much obvious contrivance. A good test of a technical indicator is whether it can applied without access to a chart, i.e., is it quantifiable? Moving averages: check. Breadth indicators: check. Manually drawn triangles and wedges: hmm.
- Quantitative analysis: whether it’s LTCM picking up basis points in front of a Russian steamroller, or Lehman holding on to the worst of the worst of the subprime tranches, the growing hatred of Value at Risk (VaR) models seems justified. Traders willing to ignore statistical tails (whether fat or not) deserve to be struck by the poisoned spikes of those tails.
Notice that all of the criticism directed at each approach tends to be justified precisely when that approach begins to float free from its objective moorings. Funamental analysis unconstrained by actual present earnings is just fortune-telling; technical analysis that massages perceived visual patterns is just chiropractic; quantitative analysis that fudges the statistics is just qualitative guesswork.
But, at their best, these approaches are all grounded in real data, and can yield interesting ideas and valuable, tradable edges. The salient point is not the choice among these three (or any other) schools of market analysis, but rather the choice between a disciplined, objective approach and something easier and inevitably dangerous.
For some similar comments along these lines, check out a recent interview that Barry Ritholtz gave.
Photo courtesy of Flickr user pagedooley.