Value investors and traders must swim together or drown
IT'S not enough to upset just one group of investors in these articles, so let's play it safe and upset them all.
Why do value investors persist in declaring that they can't time the market, without even trying and at the same time why do technical traders persist in treating shares like cabbages and trade Woolworths or CuDeco without respect to quality and therefore risk? Why not try a little bit of both?
Being narrow in approach is an Achilles heel for any investor and in a very nervous market why would you close your mind to anything that helps? It is surely not good enough for a value investor to declare a company a good company and label it a buy while ignoring the fact that the money is made out of share prices not companies.
If you're trying to guess where a share price is going you cannot dismiss share price drivers such as trends, sentiment and non-value based factors because they too go into the money-making equation and making money is what the game is all about, not valuing companies.
Both are related but are not the same and if you want to do better you need to study the whole equation, all the factors, and not just one. Why limit your options?
And for technical traders, excuse me, but isn't your craft all about identifying stocks that have a higher than random probability of doing what you think they will and trading them in preference to others?
Do you not think therefore that a knowledge of the fundamental qualities of a stock is going to enhance that practice? Aren't your odds of making a successful trade going to be improved by buying a stock that achieves a high return on equity rather than one that doesn't? And won't you be better off knowing to avoid shares of a company whose balance sheet is shot? Would it be useful for instance to know whether you are trading in a Greek bank stock or an Australian bank stock?
In a market that goes up 11.7 per cent a year (the average annual compound return on the All Ordinaries Index in the 33 years from 1974 to November 2007) almost every investment approach will work and you can safely ask investors to believe in any theory to do with making money out of shares and not disappoint them.
With 11.7 per cent average annual returns there is easily enough room for value investors and technical traders to operate independently as every approach works, no matter how incomplete. It will hide a lot of sins, black-box theories, DVD courses and selling wrapped up as education.
But it is now a very different market. It is tough, and you have to ask, in a market that has fallen 54.5 per cent, risen 60.7 per cent, fallen 25.2 per cent, risen 13.2 per cent and is still 37.7 per cent down in the past 4½ years, whether things haven't changed, whether any approach will still work, whether you can still ask investors who have survived the global financial crisis, are down 37.7 per cent and are sick of losing money, to still trade in any old stocks and make money. Or should they put their faith in a value approach in the long term when further devastation is seemingly so possible in the short term?
Without a rising tide this has become a traders' market. A cliche for sure, but this time it's true. No one wants to set and forget any more. You have to do better than that. You have to have trading skills.
But more interesting than that is the revelation that rather than put the value approach in mothballs until the next bull market, it has suddenly become more relevant than ever. In a market being priced on risk and populated by investors who are risk averse, what more valuable tool could you have than a filter to identify the best stocks? And that's what the value guys do best. They are the market's quality filter and they now provide an essential service for the traders.
And that's the formula. The value specialists find the stocks and the traders work out when to trade them. It's called synchronised swimming and without each other, they're both going to drown.
Marcus Padley is a stockbroker with Patersons Securities
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