36 PROFESSIONAL PRACTICE S BY Controversy between thetwoschoolsisstillalive andwell Fundamental vs. h s fbt eso ol.“eemploy “We tools. of sets both of use the fundamental analystswhoreadily admit Frankfurt, Germany. director &CIOofUNIONPanAgorain Andreas Sauer, Ph.D.,CFA, managing patterns inpastpricemovements,”says stocks orbondsthanjustlookingat much deeperframeworkforvaluing technical analysisbecauseitprovides a mental analysishasmore valuethan ation administerstheCMTdesignation. tech- nician. TheMarketTechnicians market Associ- chartered as well as analyst the designationofchartered financial both achieved and analysis technical and straddled thesubjectsoffundamental 380 investmentprofessionals whohave that bearshisname.Heisoneofthe r charlatanism.” and chicanery as analysis fundamen- most tal analyststendtothinkoftechnical Yet sell. or buy to when would pullouttheircharts todecide stocks and,whennoonewaslooking, tal analystswouldgettheirlistoftop , CFA, CMT. “Fundamen- fundamental analysts. cial statementsinthedeskdrawersof similarly hiddenunderstacksoffinan- to some,technicalanalysistoolsare the pagangodsofages.”According Catholic altarinSouthAmericalurk lives. Asthewritersaid,“Underevery weather, plentifulcrops, andhealthy celebrate theritualsthatbrought good in theNewWorld, peoplecontinuedto Catholicism amongindigenouspeoples esearch andassetmanagementfirm

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90 90 CYNTHIA HARRINGTON, CFA HARRINGTON, CYNTHIA

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50 50 40 40 30 30 Sauer belongstothecommunity of “In general,Ibelievethatfunda- Beach Manhattan the runs Bollinger “It’s anoldWall Street tale,”says that despitetherapidspread of can historianonceremarked isn’t soobvious.ASouthAmeri- ometimes thetruthofamatter Po r tfolio PERFORMANCE F MAGAZINE CFA after all,thenthere isno opportunity to technicals. Ifthemarketisefficient often whatfundamentalsuse to attack the efficient markethypothesisismost explains Bollinger. “Thewholeideaof damental andtechnicalanalysts,” other. “There are forces polarizingfun- much more warlikestancetoward the ents tooneschoolofthoughtassumea tal analysescoexist,however. Adher- middle where technicalandfundamen- and thefinesttechnicaltools.” made upofthefinestfundamentaltools each box,”hesays.“Rationalanalysisis would betousethebesttoolsfrom on awhitecar?Therationalapproach would youdoifwantedtowork cars’ and theother‘toolsforbluecars,’what red for ‘tools labeled one toolboxes, “rational analysis.”“Ifyou’vegottwo analysis almost20yearsago.Hecallsit juncture of technicalandfundamental the usefulnessoftechnicalanalysis.” these three factorsweget80percent of oscillators. We believethatwithjust averages, movingaveragecrosses, and our- outsmart selves,” saysOrndorff. “We usemoving to not try “We indicators. manager employsacoupleoftechnical US$40 billionassetandmutualfund and fundamental.” split pretty evenlybetweentechnical ing ofpurchase andsaledecisionsis securities wewanttoown.Butthetim- r equity,” hesays.“Fundamentalanalysis tal analysisforbothfixedincomeand “We usebothtechnicalandfundamen- USA, isalsoanunabashedmember. Payden &Rygel, LosAngeles,Calif., aging principal,headofequitystrategy, of ourownequityandbondmodels.” andreversal factorsinall eally drivesthedecisionofwhich Not allprofessionals standinthe Bollinger coinedthetermfor Like Sauer, Orndorff’s group atthe Christopher Orndorff, CFA, man- JAN-FEB 2003 JAN-FEB one ofthosein thenewcamp.“We tal Management,Atlanta,Ga., USA,is tor andsenioranalystforTrusco Capi- earnings growth, andcashflow.” r parts offundamentalanalysis.Someuse and statisticalpower, andincorporated it rigorous, fired itupwithhigher math edge from thetechnicalapproach, made technical analysts. They’re gettinghighlypaid,unlike of doorslabeled‘quantitativeanalyst.’ big institutionstoday, youwillfindlots Bollinger. “Ifyougodownthehallsin calling themselvesquants,”says with agreat bigpiececleavingoff and munity hassplitinthelast20years analysis. “Thetechnicalanalysiscom- new opponent—thatofquantitative both theupanddownmovements.” last coupleofyearsare agreat example, sometimes inefficient. Peoplemissthings.The are markets all think We rate. age returns. it’s impossibletomakeanyabove-aver- is reflected inthecurrent price,and efficient the market andbelievethatallinformation of form strong the to adhere Orndorff. “There are investorswho versy betweenthetwoschools,”says analysts looktofind.” find theinefficiencies thattechnical • • • • • KEY POINTS elative strength withideaslikealpha, spectrum. at oppositeendsofthephilosophical are analysts technical and theory market Pr both. use who analysts for buy to when to buy;technicalanalysischooses F financial healthofcompanies. F financial condition. are independentofthecompany’s T belief thatthemarketisnotefficient. T echnical analystsuseindicatorsthat echnical analysisisbasedonthe undamental analysischoosesstocks undamental analystsfocusonthe oponents ofstrong formefficient Edward Best,CFA, managingdirec- “They tookalarge bodyofknowl- T accu- entirely that’s think don’t “We “Sure, webumpintothecontro- echnicians are alsofacedwitha don’t use technical analysis, we use I believe that relying on one kind of technician is nothing more than a psy- quantitative,” says Best of the decision- information to find superior stocks or chologist looking to determine and making process for the US$47 billion bonds carries too much risk.” describe the mood of the market,” he under management for institutions and Researchers are looking for con- says. “In many cases, the behavioral the STI Classic Family of Mutual Funds. nections between the statistical rigor of finance practitioners cleaved off tech- “Technical analysis is related to stock the quantitative world and the potential nical analysis and renamed the work price and , things like charting of technical indicators. One study pub- they do. They just wrap the old in dif- price momentum. Quantitative is statis- lished in the Journal of Finance in August ferent wrapping paper.” tically based. We use excess return 2000 by Andrew Lo, Harry Mamaysky, While the controversy continues forecasting and fundamental indicators and Jiang Wang concluded that a bridge to grow, at least one person believes such as earnings, earnings trends esti- over the gulf between technical analysis that more fundamental analysts are mates, and growth rates.” and quantitative finance could be built checking their charts these days. “Lots Sauer admits to using technical on the smoothing technique of “non- of analysts are more cynical today. indicators but sets his work in the parametric kernel regression.” The sta- More are agreeing with the technical broader context of quantitative model- tistical method “identifies regularities analysts who say that financial num- ing. “In general, quantitative analysis is in time series of prices by extracting bers don’t mean a thing and the books based upon the idea that an investment nonlinear patterns from noisy data,” have always been cooked,” admits philosophy can be expressed as a statis- which expands on the otherwise linear Orndorff. tical model. A quant model may be data series in technical analysis. The “But to say that all they need to built on a variety of different sources of authors concluded that “traditional pick stocks and bonds is to see price information or factors to find underval- technical analysis can be improved by movements doesn’t seem to be enough ued securities,” he explains. using automated algorithms, and theirs either. That method is no different than “A pure ‘technical analyst’ is look- is one of many possible techniques.” trading wheat, corn, or cattle futures,” ing for specific price patterns in the (Joseph D.V. Vu, CFA, The CFA Digest, he says. “Most CFA charterholders past to predict the future and builds his February 2001) differ with that approach, or we did analysis solely on these factors. A quant Nor are the quants the only defec- all that studying for nothing.” usually relies on a more diversified set tors. Bollinger says the new field of Cynthia Harrington, CFA, is a financial of information. I’m a strong proponent behavioral finance broke away from the journalist with 20 years’ experience in of quantitative analysis based on a technical analysis fold as well. “Right at the investment business. diversified set of information because the heart of the matter is that a market

TOOLS OF THE TRADE

Technical Analysis Trading Rules and Indicators Fundamental Analysis Valuation Models and Factors

Trend channels Dividend discount models levels Free cash flow models lines Residual income models Price to earnings ratio Charting of prices and volume Price to book ratio Contrary opinion indicators Price to sales ratio Mutual fund cash positions Price to cash flow ratio Credit balance brokerage accounts Enterprise value to EBITDA Investment advisory opinions Dividend yield OTC versus NYSE volume Return on equity CBOE put/call ratio Operating and profit margins Traders bullish on stock index futures Asset turnover ratios Follow the smart money Leverage ratios Barron’s confidence index Earnings growth rates T-bill/euro spread Free cash flow growth rates Short sales by specialists Growth rates of dividends, cash flow, and earnings Breadth of market Risk free rate and risk premium Short interest

Stocks above 200-day moving average Sources: Investment Analysis and Portfolio Management, Block uptick-downtick ratio 6th edition Analysis of Equity Investment: Valuation

CFA MAGAZINE JAN-FEB 2003 37