The Truth About Fundamental Analysis And Equities

You Can Not Use The Objective Past To Predict A Subjective Future

By: Christopher Roman

Many people ask me about investing and how it is connected to fundamental analysis. This is how I view fundamental analysis, in general.

You can not use the objective past to predict a subjective future

To most investors, fundamental analysis is warm and comforting to people that have their life savings tied to equities or stocks. The truth is, most institutional investors almost never keep open interest in the markets after they close. Meaning, they never keep open risk in the markets at the end of the day.

(But) Why?

There is no fundamental analysis that can predict a pandemic. There is no algorithmic system that can predict whether or not the Deepwater Horizon is going to explode. Just as there is no IT system that is going to predict whether or not the Exxon Valdez will run aground on Bligh Reef. Or the sudden and ignominious failure of the mortgage-backed securities markets.

You might be thinking, that these are just the most extreme examples and this does not happen every day and over the long term I will come out with a positive P/L in the end. Remember, within the economic cycle, there is a fiscal crisis every 10 years. Of course, 10 years is just an average and a crisis could manifest itself every 6 years over the next 20 — It is impossible to predict.

Thinking in terms of the average time to a crisis, there is no pre-ordained mandate in the universe that guarantees a return on your investments. The managers of large pools of capital are busy in the halls of congress giving payouts to your elected officials. Guaranteeing that the odds are stacked against their constituency. The interest surrounding finance capital buying homes for senators on the Nevada side of Lake Tahoe is perfectly normal. Your money is secured by the very same senators that are being paid to work against your interests. Under these conditions, the outcome should be obvious.

Therefore, if you keep unhedged risk or blindly keep open interest in the markets and a Black Swan event manifests itself– you will lose 3/4 of your retirement savings. This scenario is bad enough if you’re 25. When your 65 it is a catastrophe.

Many investors that do not understand the nature of the markets wonder where the settlement capital ends up at the end of the crisis.

The money ends up in the hedge fund manager’s pocket.

This is simply due to the fact we have flattened our positions and are actively managing the risk. It’s that simple. Fundamental analysis is used within the investment community to give retail investors the illusion of control.

For example, regarding MACD’s (Moving Average Convergence Divergence) and using this strategy as a baseline for price discovery is — a fool's paradise. In reality, the MACD is once again trying to use the objective past to predict a subjective future. It derives data from the past, to predict price discovery. In the end, the indicator will break down and fail.

Of course, many investors swear by fundamental analysis, and I say, “more power to you”. At least from my experience, in the cases that I have seen it work–- it has just been blind luck.

When working on analysis derived from chaos. Your mind tends to draw conclusions that are not correct. Just as your mind sees images in the clouds. And just as your mind draws conclusions that are based on a chart. It will draw conclusions that are based on patterns on a chart from the objective past. Even worse, as you’re doing this pointless work your mind is telling you that your work will reward you with a positive outcome. If you dig a hole and fill it back up again; you will get the same satisfaction. And that is why fundamental analysis is delusional thinking.

What is really happening behind the chart, anyway? Your investment capital goes into the order flow or the order book. It does not matter if you are buying the most complex derivatives or a single share of Apple stock. From there, that is where the chart is made and there is nothing fundamental happening in this realm. This is where investment banks set the prices for all commodities and equities. Not because investment banks think the price of WTI Oil is at 65. These banks are trying to drive their competitors out of the market.

In fact, the investment banks and hedge funds do not care if the price of oil is at 65 or 75. They need to get a decent spread on their hedging activities for real business needs.

It’s sharks devouring sharks.

There is nothing that is fundamentally happening during the trading day except large capital driving the markets to meet their customer’s interests. If you think you can beat them with a strategy of fundamental analysis you will be crushed into powder at the end of the day. We use your capital to hedge every imaginable commodity and collect a fee and spread. We don’t care if the price goes up or down. Keeping this in mind, think twice before you enter this realm — fundamental analysis will break down and fail every time.

Market capital that is actively managed has a far better chance than a static strategy that is simply following a trend. In the end, keeping open interest in the markets that are not being actively managed is a recipe for disaster.

Many people think this is a wicked system and why does it even exist? That is a good question. The fact is, money flows to where it has the best probability of making returns and has the most liquidity to be hedged. This is due to the treasury markets liquidity and the strength of the United States military. On an average trading day, the US treasury market will exchange $600 billion. On a really busy day, it will exchange up to 2 trillion in one day. There are no other markets in the world that can accommodate this kind of volume and liquidity. China does not even come close and Russia is so far behind these numbers, it may take centuries to match these economies of scale.

In closing, don’t be drawn in by the myriad of (so-called) strategies that use historical data to predict the future of the markets. Yes, sometimes the information does produce positive results. But, so does going to Las Vegas and putting your money on [Red] or [Black]. That too can produce positive returns and fundamental analysis. As well as draw speculations of returns for some future date.

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