Is technical analysis valid in our modern times? Given the onward march of the US stock markets over the past 16 months, this may be a fair question.  

History tells us that markets have cycles of optimism and pessimism and those cycles are predicted in advance by the activity in the public markets.  The key to the stock market’s role as a lead indicator is the information that’s available and which is reflected by the action of participants acting on that information. 

One can argue that the nature of information has changed over the past decade as market activity has concentrated into the hands of fewer and fewer very large money pools.   Most people these days are likely passively invested in the markets via mutual funds, or industry ETF’s.  There’s nothing wrong with that, since those outfits are presumably paying savvy professionals to do the hard work.  All you have to do is sit back and collect coupons.  The only drawback of this approach is that your returns will be ‘average’ instead of benefitting from what options industry people express as gamma.

In fact, many money managers themselves are investing client funds in industry groups via bundling.  If for example, a firm’s analysts expect that the outlook for semi- conductors is bright, they will likely buy a basket of semi-conductor stocks to ride the trend.  This makes sense. For this reason, we can see that when an industry sector is viewed favorably, the halo effect will be reflected among all individual companies related to that space regardless of operational status.

We recall in recent years the clamor to be in any stock issue related to the burgeoning marijuana industry.  Years later, while some have survived, many of the peripheral companies did not.  That sector has cooled considerably as the initial euphoria has subsided.

The electric vehicle and associated fuel cell industry were very much in play for most of 2020.  This group has levelled off and only the anchor stock in this group, TSLA remains near the highs. Of course, stay-at-home related issues have been generally strong over this same period, thus AMZN, SHOP and the like are near their highs.   Technology issues such as AAPL, MSFT and NVDA which support this environment are also at highs.  And of course, V and MA are printing money because of online purchasing.

The fundamental reasons for the strength in these sectors are evident to anyone who is alive and consumes.   The strength of these companies has certainly been confirmed by the strong technical positions of their charts.   Depending on professionals to manage your investments is logical…only until they are wrong.  Unfortunately there is a lot of group think in that industry as can be observed when a sector collapses or surges suddenly.  Of course, when it’s time to head for the exits, they will be very crowded.

For those that are interested in making their own assessments of markets, using technical tools is a means of gauging the strength and momentum of markets and comparing that to the background news and events.   I’ve written many times on the very simple tools of trend lines and relative strength to ascertain the condition of a market or specific issue.  These simple gauges will give a rational reference when background information presents conflicting scenarios. 

While the issues referenced above have been on a positive glide path, we must always be alert to variances in their trading activity from the background news.  An example would be if Tesla reported strong results and the stock did not move higher.  The same idea can be applied to any strong sector.

On the other hand, we should be alert for negative news on a beaten down or dormant sector but which does not result in renewed weakness.  For the other half of market analysis is not just what, but as importantly, it’s when. While trends and relative strength will serve to keep you in markets that are steady, hints of divergence in that momentum are clues that the background is changing.  You will never get the top or the bottom (ask me how I know) but you will be less likely to be holding on to an investment well past the sell by date.