In Part I, I provided a simple approach to integrate technical and fundamental analysis. This is essential because most fundamental analysts have a disproportionate bias to the upside. In many respects, it is understandable because fundamental analysts follow particular companies continuously and there is no reason to do so if the performance of a company will not improve over the next twelve month period. Additionally, there is an inherent nature to believe that the future will be better than today. What is more, the market indices are designed to go up over time since laggards are replaced without restatement. Such logic is difficult for a CPA to fathom.

For example, the S&P 500 spot compared with the median target price from December 2022 through November 5, 2021 is shown in Exhibit 1. Over this period, the index was reconstituted with new leaders added and laggards replaced, and despite several major pullbacks, including The Great Recession and The COVID-19 Recession, the forward S&P forecasts were always higher, with an average 250 point spread between the spot and forward median target price.

Exhibit 1: Consensus Suggests Fundamental Analysts are Naturally Bullish

Source: FactSet as of November 7, 2021

At the time of this writing (early November 2021), the market is at all-time highs. The first of Ned Davis’ nine rules “don’t fight the tape” along with broad-based participation does not give any technical indication that the current uptrend is in jeopardy. Therefore, when looking at the individual companies included in several well-known indices, it is not surprising to expect an overwhelming consensus of buy/hold ratings as set forth in Exhibit 2.

Exhibit 2: Consensus Suggests Underlying Companies’ Fundamentals are Strong

Source: FactSet as of November 7, 2021

Euphoria does not last forever and eventually this bull market will end. The question is will fundamental analysts recognize the macro change when it does occur? There is a recent real world example that suggests the answer to that question is no.

From the January 3, 2020 closing high of WTI Crude Oil to its closing low on April 27, 2020, WTI dropped 79.7% and the XLE fell 41.4%. The energy stocks included in the S&P 500, the S&P Mid Cap 400, and the S&P Small Cap 600 indices during the aforesaid period (see Exhibit 3) remained an overwhelming consensus buy, despite many analysts forecasting WTI oil prices to remain below $70 per barrel through 2026. Even today as WTI consensus is at $68.73 and $67.55 for December 2022 and 2023, respectively, and the commodity trading above $80.00, it seems odd to be overly bullish on energy names while bearish on the underlying commodity which has had a 0.76 correlation to XLE over the past 20 years.

 Exhibit 3: Energy Sentiment Remained Bullish when Macro Fundamentals Collapsed

Source: FactSet as of November 7, 2021

Before I am accused of unfairly picking on energy – after all, nobody could have anticipated the demand destruction of COVID-19 – I looked at analyst ratings of all companies underlying today’s S&P 500 Index as of October 9, 2007 (the index’s closing high immediately before The Great Recession). At that time, there were 304 sell ratings across 6,631 analyst ratings or ~4.6%. On March 9, 2009, (the index’s closing low during The Great Recession), there were 577 sell ratings across 6,879 analyst ratings or ~8.4%. While there may be cases in which valuations are skewed, if markets are even close to being efficient, it should not be this widespread, especially in a post Regulation FD world which has persisted for over 20 years.

After staying relatively range bound from $75 – $115 from December 2010 – November 2014, WTI broke support and ultimately fell to 63% from November 14, 2014 to February 9, 2016 versus the S&P 500’s decline of 9%. WTI eventually bottomed in February 2016 and subsequently rose to $73 in September 2018 before staying range bound between $65 – $50 until February 2020 and the COVID-19 demand destruction (see Exhibit 4). Despite the structural shift in domestic production due to the shale revolution, fundamental analysts remained bullish on energy stocks (see Exhibit 5).

 Exhibit 4: WTI Monthly Chart

Source: StockCharts.com as of November 7, 2021

Exhibit 5: Energy Sentiment from 2014 – 2020 when Macro Fundamentals Deteriorated  

Source: FactSet as of November 7, 2021

I often remind people that there is much more to technical analysis than lines on a price chart. While this is an important part of technical analysis, modern technical analysis also includes risk management, statistical analysis, security screening, and understanding human psychology. These very important categories usually are ignored in fundamental analysis. A great story does not matter if no one else is buying the stock.

Exhibit 6 is an illustrative example of First Trust Global Wind Energy ETF (NYSE: FAN). Despite a federal administration that was pro-fossil fuels, FAN broke to new highs in mid-2020 and continued its ascent rising 62.3% from July – December 2021 versus the S&P’s rise of 20.5%. However, when a pro-renewables administration entered last January, as well as substantial investments in wind projects both domestically and abroad, FAN has spent the majority of 2021 in a trading range. This example demonstrates that despite favorable fundamentals due to the bullish prospects of renewable energy, particularly wind, by federal and state governments, prominent political and business leaders, and Wall Street firms, technical analysis could have provided greater alpha by exiting a long position when there was a confirmed trend changed (and either shorting FAN or finding another opportunity), trading the range, or passing all together until FAN’s price breaks out of its range. The opportunity cost of staying in a sideways trade for months often is overlooked and may not be the best use of capital.

Exhibit 6: Technicals Navigate 2020-21 better than the Macro Environment

Source: StockCharts.com as of November 7, 2021

The integration of technical and fundamental analysis results in actionable ideas beyond buying or holding for the next twelve months or selling a position today. The goal of an investment is simple – make money. While investing in companies with strong fundamentals has a long history of success, if positive returns are not occurring, a fresh analysis using different tools should not be dismissed. The time value of money or opportunity cost is seemingly often overlooked when in an underperforming investment. Being tactical, with at least a portion of the portfolio, can drive greater returns.

The case to integrate technical analysis with fundamental sell-side research is simple:

• Enables a holistic approach to the market
• Provides a real-time understanding of the market environment
• Looks at price/executed orders and not assumptions
• Facilitates efficient timing in position entries/exits
• Allows for strategic hedging to maximize alpha and reduce a portfolio’s volatility
• Enables the sell-side firm to offer a proprietary and differentiated product
• Helps drive increased client votes

Simply stated, technical analysis helps to identify when an action should be taken and when to simply “ride the wave” as opposed to discrete buy, hold, or sell decisions as of a moment in time.

Accounting and chart analysis clearly require different skillsets, but many of the core tenets that make for a good CPA also make for a good market technician. As a result, while there are few CPA – CMTs, in time, the combination may be more common, especially as more buy- and sell-side firms look to hire CPAs to assist in their fundamental analysis. For the time being, I will relish being one of the few to have both designations and continue working with friends, colleagues, and clients to better understand the value in pairing the two disciplines.