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The Flaws of Fundamental Analysis

Fellow Investing Insights blogger Ben Levisohn, a former stock trader, has a great article out on technical analysis.

Ben explains how technicians interpret the market, and defends technical analysis against charges that it’s mumbo jumbo. I remain rather skeptical of technical analysis’ methods and usefulness, but it’s definitely worth a read. And he makes a good point:

So much for fundamental research. The Standard & Poor’s (MHP) 500-stock index is down 46% from the all-time high of 1576 it hit back in October 2007. At every step of its seemingly endless decline, investors have been told one thing: Based on the fundamentals, stocks are cheap. Yet shares continue to fall.

I think technicians did a pretty lousy job, too, but it’s certainly true that investors and analysts who rely on fundamentals couldn’t predict their way out of a paper bag this year.

PIMCO’s Bill Gross’ monthly note — almost always a must-read — addresses this very issue. I think he helps explain the problem. The key passage:

My transgenerational stock market outlook is this: stocks are cheap when valued within the context of a financed-based economy once dominated by leverage, cheap financing, and even lower corporate tax rates. That world, however, is in our past not our future. More regulation, lower leverage, higher taxes, and a lack of entrepreneurial testosterone are what we must get used to – that and a government checkbook that allows for healing, but crowds the private sector into an awkward and less productive corner.

Read the whole thing.

After the credit crisis hit, the underlying fundamentals of the economy changed. We need new ways of analyzing value in the stock market.

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