Fundamentals vs Technicals

Hi,

A quick steer for those having trouble in this volatile market environment. When you buy an equity, you are in essence buying primarily 'speculation', particularly in a market like this. As the price of a stock evolves through time, solid fundamentals in a company will help push this speculation in your direction if you are long the equity. However, in a market as volatile as this, the equity will be moved less by fundamentals and more by technical flows whether they are driven by fear or speculation. In an environment as saturated in fear as we are, 'speculation' is a very volatile commodity to trade. The uncertainty around equities currently is huge and no matter how much homework you do, or how well you know a stock, you can never confidently predict the short term capital flows, or technicals, that will push the price of your stock around.

If you can cope with taking short term MTM losses then now is a great time to pick up some equity bargains in solid, fundamentally sound businesses. However, if the idea of 10 - 20% swings in price keeps you awake at night in sweats, and you want a more stable reward for doing your homework, your opportunities are to be found in shorter dated corporate bonds.

Shorter dated corporate bonds have their price anchored to a fundamental event on a definite date in the future - the bond's maturity date. If you know a stock well, you'll know the balance sheet well, and if you know the balance sheet well, you should be able to predict with accuracy whether or not the notional of the bond will be repaid. Beware companies with volatile business models that have a large percentage of their debt redeeming in the near future. If you are looking for a maturity sweet spot, try 2 - 3yrs with the total notional of debt redeeming inbetween now and then being less than 20% of the company total. For those with even less of a risk appetite, go for maturities less than 2yrs.

Using fundamentals to help you in an environment where technicals are causing huge swings in perceived company health is a savvy investment approach. The market will one day calm down, and the balance of what primarily moves stock prices will move back towards fundamental perfromance and away from panic selling. But not for a while.

One other option is to use equity derivatives to put boundaries in value around your investment. If you understand how derivatives work, they can be a very powerful tool in dampening uncertainty in your portfolio. But take caution, in the wrong hands, derivatives can cause more problems than they solve. Just ask a CDO salesman.

Happy hunting,
Andy Shaw