Technically Speaking, January 2022

Using anecdotal evidence from CMT Association sponsored events, LinkedIn, Bloomberg, and other sources, it seems that CMTs who also hold the CPA designation are extremely rare. The combination for me is attributed purely to my non-traditional career progression. A decade ago, I worked in the M&A tax group at a Big 4 accounting firm. Due to family circumstances, I pivoted my accounting/tax career to trading and ultimately combined my knowledge of accounting with my passion for the equity markets in sell-side research. Most of my sell-side colleagues hold a CFA and/or an MBA with few CPAs or PhDs and even fewer CMTs. I can generally categorize my peers into four categories: 1) some view technical analysis as “voodoo;” 2) some only believe stocks underperform their thesis for unspecified technical reasons when there was no news accompanying an adverse move; 3) some possess a cursory understanding of technical analysis but do not know how to apply it; and 4) some utilize it in the background with little to no public broadcast. All of these categories surprise me, since there is an All-American Institutional Investor category for technical analysis.

The basis of technical analysis is fundamental. Central to Dow Theory is the concept that Dow’s industrial and railroad averages should confirm a move because there is an economic rationale that goods provided and sold to customers should suggest that those goods were transported and delivered. Outside of the meme stock price action this year, companies on their way to bankruptcy generally do not trade in uptrends.

With the advent of intraday and tick charts, digitalization, and automation, the application of technical analysis has flourished greatly since the time of Charles Dow. Nevertheless, the core tenets that Dow postulated in his writings remain at the root of our application. Today some investors use technicals almost exclusively, and with quantitative investing, there is an element of technical analysis necessary in writing many algorithms. Technical analysis has become so encompassing that on a sliding scale from 0 to 100, the integration of technicals with fundamentals could sit anywhere on the scale, with the optimal spot likely in the middle.

CPAs are expected to exhibit professional skepticism which is immeasurable, but essentially requires CPAs to be inquisitive, question reasonableness, and test procedures. This is essentially the scientific method which technicians routinely employ. Furthermore, CPAs are instructed to practice conservatism which essentially instructs an accountant to avoid overstating revenue/assets and understating expenses/liabilities. While applied differently, technicians also exhibit conservatism. We know that most of the indicators in our toolbox are conservative. We look for divergences as a signal not necessarily to go long or short but as an indication potentially to move to cash, which is conservative. Does that mean we may miss a favorable move? Yes, of course! However, we are willing to accept it, because capital preservation in a time of uncertainty might better align with our risk profile.

As a CPA, I know that financial statements are reasonable estimates of a company’s financial position, operations, and funds flow; however, financial statements can be restated or reformatted in a way that negates comparability with competitors. Each company can select its own accounting methodology for various line items, which makes even a comparison of the same line item between two companies in the same sector with roughly the same attributes, difficult. Simply put, despite the time and cost of preparation and the Regulation G requirement to reconcile a non-GAAP measure to a GAAP measure, financial statements of companies are not necessarily comparable and oftentimes are determined using assumptions within defined parameters. In short, accounting is as much an art as a science.

I believe that there should be a fusion of the two methodologies – because they are complementary and not incompatible. Marrying the two disciplines enables an analyst to provide a holistic view of not just the company/sector, but the reasonableness of the assumptions – particularly entries, target prices, and valuation. Simply put, it is an alternative path to arrive at the same place – alpha generation.

Using the keep it simple approach, fundamental analysts can utilize technical analysis in the following ways:

• Time rating changes
• Determine relative strength and rank a coverage universe
• Provide clients with perspective during market sell-offs and offer reasonable reversal levels
• Adequately explain day-to-day market gyrations especially when there is no news
• Identify confluences as a reasonable check to fundamental target prices
• Offer clients actionable ideas to generate alpha

In an age when information is widely disseminated, the marriage of fundamental and technical analysis provides a value-added service. Technical analysis typically can be much more objective than fundamental analysis. For example, when drawing support and resistance lines, it is clear where a pivot high or low occurred; they are measurable and objective. Shares, units, or contracts actually traded at a particular level also are measurable. Yes, there are subjective elements to technical analysis and this subjectivity oftentimes causes the skeptics to discredit the entire discipline. But I advocate, especially when dealing with fundamentalists, to keep the approach purely factual and objective. Yes, point out a head and shoulders pattern when you see it but do not lead with it. Instead, lead with the facts and be sure the analysis is understandable to non-technicians. Over time, this approach should bode well for the integration of the two disciplines.

In Part 2, I will highlight the practical reason for the overlay of technical analysis with fundamental analysis.