Indoctrinated by the efficient market theory in business school, many people in finance enter the real world only to find out that things work quite a bit differently.On many occasions you buy a stock that is cheap at 10 times earnings -- only to find out that it can expeditiously drop even cheaper at five. Business schools teach primarily security analysis -- the more strategic part of investing -- which without a doubt the most important. But business schools rarely teach anything about market timing or tactical trading, where technical analysis plays a valid role.
The charlatan investment experts that I worked with once -- a truly comical individual -- used to stare at charts all day and then throw out a PE or a book value metric to justify his take on a stock. He would describe himself as a value investor, but I have never seen him look at a balance sheet or an income statement. This is why he made stupid trades and lost quite a bit of money over the years. There was a lot of ambition, but not the appropriate level of ability necessary for greatness.
Great Minds Think Alike
Chris Wood, the strategist at CLSA Asia Pacific Markets, whom I have had the pleasure to read for several years, is a deep fundamental investor. But when he once said that charts are not entirely hocus pocus, it caught my attention. I have heard the same from Dr. Marc Faber, another great long-term thinker, and from George Soros, one of the greatest traders in recent memory.
Above is a chart of the Shanghai Composite. After making a bottom in October 2008, the Chinese market began to rally -- way in advance of other BRIC markets -- finally doubling in less than a year to almost 3,500. Currently, it appears to have completed a correction phase at around 2,500 and has held the May lows in the face of problems in Europe and crashing euro -- this is a positive.
The trading pattern is not any worse than any other BRIC market. The fact that it begun the corrective phase first from the BRIC quartet may simply mean that it may be the first one to begin rallying. How many people -- excluding the editors of this forum -- are expecting that? So far this is nothing more than a normal correction after a big rally.
If you want to see a bad chart, look at the euro, investable via the Currency Shares Euro Trust (NYSE: FXE). There are also leveraged ETFs and ETNs, in addition to options, but those I advocate for active traders only.
The euro has broken all kinds of lows from 2008 and is currently trading even lower. Unlike the correction in the Chinese market, which we view as healthy, the euro is experiencing a rout. So from a trading perspective it "might bounce" as they as they say to 1.25, but if the fundamentals are rotten, as I believe, this will be a bounce to sell -- as opposed to the Chinese market which has given you an opportunity to buy.
Can BRICs rally with a falling euro? There is an indication in the chart above. The dark line represents Claymore/BNY Mellon BRIC ETF (NYSE: EEB), while the red represents the FXE. Looking at the EEB chart is meaningless without understanding what stands behind it. Is this ETF representative of the BRIC quartet, or is it just a marketing ploy like many ETFs. Let's investigate…
EEB ETF HOLDINGS | TOP FUND GEOGRAPHIC WEIGHTING | ||
PETROLEO BRASILEIRO ADR (PREF) | 7.70% | Brazil | 55.30% |
VALE SA-SP PREF ADR | 6.91% | China | 29.54% |
PETROL BRASILEIRO | 6.55% | India | 11.90% |
CHINA MOBILE (HONG KONG) LTD | 6.42% | Russia | 3.26% |
VALE SA - SP ADR | 5.19% | SECTOR WEIGHTING | |
ITAU UNIBANCO BANCO MULT | 5.17% | Energy | 24.87% |
INFOSYS TECHNOLOGIES LTD ADR | 4.05% | Materials | 20.38% |
BANCO BRADESCO SA ADR | 4.03% | Financials | 18.91% |
CNOOC LTD | 3.86% | Telecommunication Services | 12.79% |
CHINA LIFE INSURANCE CO-ADR | 3.34% | Information Technology | 8.06% |
I like this ETF. It is a little overweight Brazil, which is not a bad thing, and a little too underweight Russia -- some might like that. Given that Brazil and Russia are both heavily reliant on natural resources, this isn't really an issue. Both India and China are well-represented.
The EEB rallied through April as the euro declined. When the decline turned into a panic, then we had a sharp BRIC correction. So as long as the EUR bottom does not fall out, the BRIC rally thesis held here -- materializing in fits and starts since we began talking about it a few weeks ago -- has validity. This EEB is actually a pretty good buy right here.We want to be victorious, but not take forever to do so, which is why we have to use all tools available. We certainly don't want to be like our charlatan investment expert that looked at charts all day and talked about PE's, but in the end understood neither, which is why he ended up constantly just paraphrasing Barron's.
To summarize: trading is tactical -- you need the ability to read a chart and use indicators -- while investing is strategic. You better know your fundamentals well.
As the great Chinese general Sun Tzu said many centuries ago: "Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat." Invest accordingly.
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