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Writer's pictureKashyap Sriram

The Weakness In Fundamental Analysis

This article was originally published in the Against All Odds Research October 2021 Issue


My wife and I stopped at a supermarket and stocked up on everything we wanted, had dinner at an Asian fine dining place where the food was flawless, and stopped by at a patisserie and got everything we wanted. That's when it hit me that my experience out here in the third world stands in stark contrast to the stories I'm hearing of shortages and price inflation in the US. What gives? Is India in fundamentally better shape than the US of today?


Of course not. The answer lies in thinking through the seen and the unseen. In my city, the population has thinned out as the marginal workers who could no longer afford the cost of living have moved back to their hometowns. Demand has absolutely collapsed. A city which previously housed 11.2 million people now houses say 8 million or lesser. Naturally, it feels as though there's an abundance of resources, when in reality, people have actually become poorer and lowered their standard of living. You just don't see them on the streets because they're no longer there.


It's the same case in the US. The after-effect of the government reaction to the plandemic is shortage of goods as containerships are backed up, and shortage of workers as universal basic income and immigration control has destroyed the supply of low-skilled labor.


In the US, government intervention is showing up directly in price inflation and shortages. In India, it's showing up as a surplus of goods and stable prices in the cities.


I bring this up because there's a lesson in this for fundamentals based trading. I could have stopped my narrative anywhere in the first few paragraphs and arrived at a different fundamentals-based view. I could go on with the narrative and perhaps form a different fundamentals-based view altogether.


And that's really the weakness of fundamental analysis. It cannot account for human action, which often ends up changing the fundamentals. A fundamentals based view must incorporate human action in order to correct for this weakness.


In the real world, that's not easy. Fortunately in the world of trading, it is really, really easy. What incorporates human action and tells us how people have actually reacted to what they believe to be the fundamentals? Price and volume. It's really that simple. If you consider yourself a fundamentals based investor but refuse to acknowledge price and volume (i.e. human action), you're really only constructing abstract hypotheses unconnected to reality.


Which is the problem I see with most gold bulls today.


I absolutely think gold should do great in the current environment. But it hasn't. Human action, as expressed by the price and volume action, has shown that the market actually doesn't agree with the gold bulls on the fundamentals. From 2012-18, the market disagreed with the gold bulls on where the price of gold should be. That's just how markets are.


Some market gurus consider themselves geniuses because they have a fundamentals based view which flies in the face of the price action. They know, with absolute certainty, that their view is right and the market is wrong. They double down on bad calls. They make themselves miserable by piling on losses, seek solace in the losses of like-minded masochists, and become bitter because fellow human beings who view the world differently are making money while they aren't. How can that idiot Robinhooder make money while I, the know-all market wizard who predicted everything, am losing money?


Yes, the markets are manipulated all the time. By human action. It's evident in the price and volume action. If human action runs counter to one's pet fundamental theory, is the theory wrong or is human action? It doesn't matter. The right question to ask is - if my fundamental theory isn't helping me make money, do I stick with it or alter the theory to help me make money?


Fundamentals get a bad rap because the practitioners never alter their pet theory. Those pet theories aren't about fundamentals at all, and should be recognized as such. The market gurus who boast about their contrarian predictions making 1000% gains aren't actually making those kind of gains in their portfolio. If they were, they'd be billionaires. And they would definitely not be selling their predictions.


Fundamentals isn't about predictions or pet theories. It's about looking at the world and forming an opinion (or theory, since that sounds better). Trading is figuring out how best to use those theories as a basis for making money.


I have a fundamental view on every sector and security I look at. It's important to my style of trading to have that view. However, I do recognize the inherent weakness of using fundamentals. When the price action runs counter to my theory, I alter it. I'll be wrong often - but I'll make money. I won't be wedded to one side of the market on a single asset class until death (or bankruptcy) do us apart.


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