Latest / How Canadian Markets Work / Episode 69: Fundamental vs Technical (The Two Religions)

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Episode 69: Fundamental vs Technical (The Two Religions) · How Canadian Markets Work

0:00
Picture two people, and they're staring at the
0:02
exact same stock ticker on the screen. OK, I'm
0:05
picturing it. So the first person is just buried
0:08
in five years of audited financial statements.
0:12
They've got these deeply complex, discounted
0:14
cash flow models, granular industry supply chain
0:17
reports, and they're absolutely convinced they
0:20
know what the company is truly worth. Right,
0:22
doing all the heavy math. Exactly. But the second
0:25
person, they haven't glanced at a single income
0:28
statement. Like, not one. Instead, they're just
0:31
staring at a candlestick chart of the stock's
0:33
price history. Just looking at the squiggly lines.
0:35
Yeah, tracking relative strength, analyzing trading
0:38
volume over the last 90 days. Yeah. And they
0:41
feel equally convinced that they know exactly
0:43
where the price is going next. And the funny
0:45
thing is, both of these people think the other
0:47
is completely delusional. Oh, absolutely. They
0:49
despise each other's methods. All right. So today
0:52
we are doing a deep dive into these two great
0:55
warring religions of the market, fundamental
0:58
and technical analysis, and we're going to pit
1:00
them against a third highly controversial philosophy
1:03
that basically looks at both of these passionate
1:05
groups and claims that they're both completely
1:09
wasting their time. And what's fascinating here
1:11
is that even if you never pick a single individual
1:14
stock yourself, even if your entire strategy
1:18
is just buying a target date passive index fund
1:20
for your retirement, these three philosophies
1:23
still dictate your financial reality. Really?
1:26
even if I'm just totally hands off. Well, 100%.
1:28
They are the underlying engines of the whole
1:30
global financial ecosystem. I mean, they dictate
1:33
how multi -billion dollar institutional pension
1:35
funds allocate capital. Yeah. And they shape
1:38
all those wildly contradictory arguments you
1:40
hear from the talking heads on financial networks.
1:43
And ultimately, they determine the moment -to
1:45
-moment pricing of literally every asset you
1:47
hold in your portfolio. So understanding the
1:50
tension between these lenses is, well, it's the
1:53
only way you truly learn to read the market.
1:55
behavior. Okay, let's unpack this. We basically
1:58
have two primary lenses that view the world through
2:01
entirely different core beliefs. Let's start
2:04
with the fundamental analyst. Right, the spreadsheet,
2:06
folks. Yeah, exactly. They operate on this premise
2:09
that a security has an intrinsic value and that
2:12
value is dictated by the actual real -world business.
2:16
They do not care about the ticker's daily fluctuations.
2:19
No, not at all. They care about, you know, operating
2:21
margins, the debt load, the competitive moat.
2:25
Right. They build a model, they calculate a hard
2:27
dollar value, and then, and really only then,
2:30
they look at the current share price. And if
2:32
the market price is lower than their calculated
2:34
intrinsic value, they buy. Because the theory
2:37
there is that the price will eventually converge
2:39
toward its true value, right? It assumes the
2:41
market is currently acting irrationally, but...
2:43
You know, it will eventually wake up and price
2:46
the asset, correct? It's basically like buying
2:48
a house based purely on a structural inspector's
2:51
appraisal. You look at the foundation, the copper
2:54
plumbing, the roof lifespan, and you calculate
2:57
exactly what those raw materials and that plot
2:59
of land are worth. That's a really good way to
3:01
think about it. Yeah. And if the asking price
3:03
is lower than your number, you pull the trigger.
3:06
But I have to push back here. OK, go for it.
3:09
If I buy a stock purely because some spreadsheet
3:14
of future cash flow says it's cheap? What force
3:17
in the universe actually compels the rest of
3:19
the market to ever agree with me? Like saying
3:22
the price will converge eventually feels like
3:24
an incredibly dangerous crutch for an analyst.
3:27
Hey, you hit the nail on the head. It is the
3:29
ultimate structural trap of fundamental analysis.
3:32
A model can just scream that an asset is mispriced,
3:35
but it cannot guarantee the market will ever
3:37
close that gap. Right. There's no law of physics
3:39
making it happen. Exactly. And this creates a
3:43
fascinating, honestly almost tragic psychological
3:46
vulnerability. Because when a fundamental investor
3:49
buys a stock and the price just leads out for
3:51
three consecutive years, they have this unfalsifiable
3:55
excuse ready to go. Well, let me guess. I'm not
3:58
wrong. The market just hasn't recognized the
4:00
true value yet. Yes. That is exactly what they
4:03
say. The fundamentalist can ride a dying business
4:06
all the way to bankruptcy, totally convinced
4:09
the whole way down that the stock is just getting
4:11
cheaper and more attractive. Man, it's brutal.
4:14
It is. From the outside, a brilliant contrarian
4:17
investor who's just early and a terrible investor
4:20
caught in a value trap. Well, they look completely
4:23
identical. So if fundamental analysis has this
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massive value trap blind spot where you are battling
4:29
the market's timeline. How do traders strip that
4:32
emotion and guesswork out of the equation? Well,
4:35
that is exactly where the technician steps in.
4:37
Right, because the technical analyst ignores
4:39
the underlying business entirely, right? They
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don't care what the company makes, and they definitely
4:44
don't read the footnotes of the annual reports.
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They probably don't even know the CEO's name.
4:48
They study price and volume history, operating
4:50
on this assumption that market psychology and
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supply and demand mechanics just, you know, they
4:55
repeat themselves over time. Which sounds a little
4:57
crazy to the fundamental folks. It does. We should
5:00
probably provide the steel man argument for technical
5:03
analysis here because it is super easy for fundamentalists
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to just dismiss it as reading tea leaves or astrology
5:10
for men. Yeah, I've heard that one. So what is
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the best defense of it? The strongest defense
5:15
of the technician is the core belief that the
5:17
price chart discounts and contains everything.
5:21
Every piece of known public information, every
5:24
macroeconomic shift, and crucially, all the hidden
5:28
private information, too. Right. Because if a
5:31
massive institutional shareholder is quietly
5:34
unloading millions of shares or, say, a C -suite
5:37
executive knows a disastrous earnings miss is
5:40
coming next week and they start dumping their
5:42
vested equity. analyst reading last quarter's
5:45
public filings is completely blind to it. Exactly.
5:48
But the technician argues that this hidden aggressive
5:50
selling pressure will inevitably leak into the
5:53
price action, right? It's going to show up in
5:54
the trading volume on the chart. Precisely. Long
5:57
before the bad news ever hits the wire, the chart
6:00
is going to show a breakdown in relative strength.
6:03
To the technician, the chart is just the ultimate
6:06
unfiltered truth of human behavior and institutional
6:09
capital flow. Okay, let's ground this with a
6:12
specific example from the sources. So imagine
6:14
a Canadian manufacturing company currently trading
6:17
at $34 a share. Okay, $34. The fundamental analyst
6:21
projects the company's future -free cash flows,
6:24
discounts those future dollars back to today's
6:27
value, and determines the intrinsic value is
6:29
actually $41. So they think it's undervalued.
6:32
Right. Because the stock is at 34, it's roughly
6:35
20 % cheap. So they buy, and they take a seat
6:38
in the waiting room for the market to realize
6:40
its mistake. And wait and wait. Yeah. Meanwhile,
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the technical analyst looks at the exact same
6:45
$34 stock, but they're pulling up an 18 -month
6:47
price chart. Completely different approach. Exactly.
6:50
And they noticed that three distinct times over
6:52
the last year and a half, the stock fell to exactly
6:54
$32. And every single time, aggressive buyers
6:58
stepped in. absorbed all the selling and pushed
7:01
it right back up. Ah, so they identify $32 as
7:04
a strong level of support. Yes, exactly. And
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they also see volume expanding on updates signaling
7:10
institutional accumulation. So the technician
7:13
also buys at $34. But here is the critical defining
7:18
difference between these two religions. The technician
7:20
has a strict predefined exit plan. Right. They
7:23
aren't going to hold it to zero. No way. They
7:26
place a hard stop loss order just below $31.
7:29
If the price falls through that historic $32
7:32
support level, they don't average down. They
7:34
don't argue with the market. They just accept
7:36
that their thesis is broken. Exactly. They take
7:38
a small, defined loss and they move on. But even
7:41
that discipline has a massive vulnerability,
7:43
right? Because sophisticated players, they know
7:45
exactly where those retail stops are parked.
7:47
Oh, absolutely they do. If everyone sees that
7:49
32 is support and everyone places their stop
7:52
loss at $31 .50, these high frequency algorithms
7:56
will deliberately push the price down to 31 .4.
7:59
Just to hunt them. Yep. They trigger all those
8:02
automatic sell orders, grab that sudden flood
8:04
of liquidity, and then ride the stock back up.
8:07
The technician gets stopped out on a fake breakdown,
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taking a loss while the stock ultimately goes
8:12
their way anyway. Which perfectly exposes the
8:14
fatal flaws in both camps, if you think about
8:17
it. The fundamentalist might be totally right
8:19
about the math, but wait forever in a value trap.
8:21
And the technician might get hunted by algorithms
8:24
or just find imaginary structure in random noise.
8:28
And this mutual vulnerability paves the way for
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the third group. Ah, here we go. Yeah. A group
8:34
of academics and theorists who look at both the
8:37
fundamentalist and the technician and basically
8:39
reject them both outright. The efficient market
8:41
hypothesis, or EMH. That's the one. The proponents
8:45
of this philosophy argue that at any given millisecond
8:48
the price is already correct. Like when that
8:50
Canadian manufacturer is trading at $34, EMHS
8:53
34 is the absolute best, most accurate, mathematically
8:56
perfect estimate of the company's value based
8:59
on all available information in the universe.
9:01
Yeah. So trying to find a bargain or some magic
9:04
chart pattern is just a total fool's errand to
9:07
them. Right. But why? Like, why would it just
9:11
automatically be correct? Well, the underlying
9:14
logic for why the market is efficient is actually
9:17
incredibly compelling. Just think about the sheer
9:19
architecture of global finance. It's massive.
9:22
Right. You have tens of thousands of well -resourced,
9:26
highly educated professionals, backed by quantum
9:29
computers, machine learning, and literal trillions
9:32
of dollars in capital. And they are all ruthlessly
9:35
competing to find mispricings. Right. So if a
9:38
stock is genuinely, obviously cheap based on
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its fundamentals, someone in that massive army
9:44
of professionals is going to buy it in a fraction
9:46
of a second. Exactly. And that buying pressure
9:48
drives the price up until the discount is completely
9:50
erased. But wait, if you follow that logic to
9:53
its natural conclusion, you hit a massive paradox.
9:56
Yes, you do. Market efficiency is entirely dependent
9:59
on people actively trying to beat the market.
10:01
The fundamentalists grinding through their spreadsheets
10:04
and the technicians hunting for inefficiencies.
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They are the actual gears of the machine that
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makes the price accurate. Yeah, they're doing
10:10
all the hard work. So if everyone suddenly believed
10:13
the official market hypothesis was true, fired
10:15
all their active analysts and just passively
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bought the index, the market would immediately
10:20
stop being efficient. There would be no one left
10:22
doing the actual work of weighing the information.
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It is the great irony of modern finance. Passive
10:29
indexing relies entirely on the heavy lifting
10:31
of active managers to keep prices honest. It's
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wild to think about. It really is. But within
10:37
EMH, the sources break down this concept of efficiency
10:40
into three forms, which basically dictate exactly
10:43
what kind of analysis is deemed useless. OK,
10:46
let's hear them. First, you have the weak form
10:48
of efficiency. This argues that past prices and
10:52
past volume contain zero predictive power for
10:55
future prices. So if the weak form is true, technical
10:57
analysis is completely dead. Completely dead.
11:00
Then you have the semi -strong form, which argues
11:03
that all publicly available information, so earnings
11:05
reports, balance sheets, macroeconomic data,
11:08
it's all instantly reflected in the stock price.
11:11
Okay, so if this form is true, fundamental analysis
11:14
on public companies is useless. Because by the
11:17
time you've calculated your intrinsic value,
11:19
the algorithms have already traded on the data
11:21
and adjusted the price. Exactly. You're always
11:23
too late. And finally, you have the extreme end,
11:26
which is the strong form. This argues that absolutely
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all information, even private, closely guarded
11:33
inside information, is instantly priced in. Wow.
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But practically nobody actually believes that
11:39
one, right? Oh, almost nobody. I mean, the very
11:42
existence of regulators sending people to prison
11:44
for insider trading kind of proves the strong
11:46
form false. If private information was already
11:49
priced in, insiders couldn't generate illegal
11:52
outsized profits. Right, that makes total sense.
11:54
OK, here's where it gets really interesting.
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We have the theories, we have the warring factions,
11:58
the paradoxes. But when we strip away the marketing
12:02
brochures, the Wall Street egos, and all the
12:04
complex jargon, what does the actual hard scientific
12:08
evidence say? Let's look at the harsh reality
12:10
of the data to see who was actually winning.
12:12
Well, the academic consensus delivered by our
12:14
sources is pretty brutal. Let's start with technical
12:17
analysis. Okay, lay it on me. The evidence supporting
12:19
consistent long -term outperformance from purely
12:23
trading chart patterns, especially after you
12:25
factor in the very real transaction costs, the
12:28
bid ask spreads and taxes, it's incredibly weak.
12:32
Which honestly isn't that surprising, right?
12:34
Because so much of this just comes down to how
12:36
humans are biologically wired. How so? We are
12:40
just desperate to find structure in chaos. We
12:42
look at a totally random scatter plot of data
12:44
and our brains invent a head and shoulders formation
12:47
or a cup and handle trend. We are literally hallucinating
12:51
patterns in financial noise. That is so true.
12:53
We're pattern seeking machines. And modern computing
12:56
power has actually made this even worse through
12:58
something called Curve fitting. Curve fitting.
13:01
Yeah, it's basically the plague of modern quantitative
13:03
analysis. With today's technology, you can run
13:06
thousands of technical indicators against decades
13:08
of historical market data in seconds. Oh, right.
13:11
And just by pure mathematical chance, if you
13:13
run enough tests, you will eventually find some
13:15
complex combination of moving averages and volume
13:18
triggers that would have produced a massive staggering
13:20
profit in the past. It's like a tailor making
13:23
a bespoke custom suit for a client. But the client
13:27
is standing frozen. balanced on one leg with
13:30
his arms raised above his head. Huh. Okay, I
13:33
like where this is going. So the tailor sews
13:36
a suit that fits that exact bizarre posture perfectly,
13:41
flawlessly. You back test it and it looks beautiful.
13:43
Right. But the absolute second you take that
13:46
perfectly fitted suit into the real world, what?
13:50
data scientists call out of a sample data, the
13:52
client lowers his arms, takes a natural step
13:54
forward, and the soup just instantly rips apart
13:56
at the seams. It wasn't a predictive rule for
13:58
how the market moves. It was just perfectly fitted
14:01
to pass noise. That is a phenomenal way to visualize
14:03
it. I love that analogy. However, I will say...
14:07
To be fair to the chart readers, there is one
14:09
major anomaly that the academic data consistently
14:12
acknowledges, and it actively challenges the
14:15
efficient market hypothesis. It's called momentum.
14:17
Right, momentum. So that's the tendency for recent
14:19
winners to continue winning and recent losers
14:21
to just continue bleeding out, usually over a
14:23
three to 12 month time frame, right? But why
14:25
does that happen if the price is always supposed
14:27
to be right? It mostly comes down to structural
14:30
and behavioral friction. Academics argue that
14:33
when a company announces a massive game -changing
14:36
earnings beat, human beings just don't price
14:39
it in instantaneously. we anchor to our old beliefs.
14:42
Oh, so Wall Street analysts are slow to revise
14:44
their price targets. Exactly. And everyday investors
14:47
are cautious, so they digest the news slowly
14:50
over a period of weeks. That delayed behavioral
14:54
reaction creates a multi -month momentum drift.
14:57
That makes sense. Yeah. And furthermore, on the
15:00
downside, you have structural forces like tax
15:02
loss harvesting. Oh, right. Where managers sell
15:04
losers at the end of the year to offset their
15:06
gains. Exactly. And that creates artificial selling
15:09
pressures. that drives the price even lower,
15:12
regardless of the company's fundamentals. So
15:14
momentum is a well -documented reality that actually
15:17
breaks the weak form of EMH. Okay, so chart reading
15:21
has momentum, but is largely vulnerable to curve
15:25
fitting. But surely the fundamental folks, the
15:28
ones doing the really intense math, interviewing
15:29
management teams, visiting the actual factories,
15:32
surely they are beating the market. I hate to
15:35
be the bearer of bad news, but this is perhaps
15:37
the hardest truth in finance. When you look at
15:40
the data over five, 10 and 20 year periods, the
15:43
vast majority of actively managed mutual funds
15:46
actively underperform their passive index benchmarks
15:49
after fees. The vast majority. That's wild. But
15:53
you know, this isn't just because fund managers
15:54
are bad at their jobs. It is literally a structural
15:57
math problem. Yes. Exactly. Think about William
15:59
Sharpe's arithmetic of active management. The
16:02
market return is just the weighted average of
16:04
all participants. So before fees, active trading
16:07
is just a zero -sum game. Right. For every winner,
16:10
there's a loser. Exactly. For every brilliant
16:12
manager who buys a stock at a discount, someone
16:14
else had to sell it to them at a loss. As an
16:17
aggregate group, active managers literally are
16:20
the market. Therefore, before fees, their average
16:23
return has to equal the index. The math doesn't
16:26
lie. But once you deduct a 1 % management fee,
16:30
the transaction costs of trading, and the tax
16:32
drag from constantly churning the portfolio,
16:35
active management becomes a negative sum game.
16:37
It is mathematically guaranteed that the aggregate
16:40
active manager will underperform the passive
16:42
index. Now there are absolutely exceptional individuals
16:45
who do beat the market long -term, but identifying
16:48
them in advance is nearly impossible, and their
16:51
passed out performance is statistically a very
16:53
weak predictor of their future results. So if
16:56
neither method consistently beats the market,
16:59
and the math is just heavily stacked against
17:01
active analysis, Why do these tools even exist?
17:04
Why did we just spend all this time dissecting
17:06
them? Well, if we connect this to the bigger
17:08
picture, the true practical value of these tools
17:11
for you, the listener, isn't about guaranteeing
17:14
excess returns. No. Then what's it about? It
17:17
is about how these frameworks manage your behavior,
17:19
your psychology, and your risk in a highly uncertain
17:21
environment. Let's look at fundamental analysis.
17:25
Understanding the business you own, knowing its
17:27
debt profile, its margins, its durable competitive
17:29
advantage, that is an incredible behavioral anchor.
17:32
Oh, I completely agree with that. If you just
17:34
buy a random stock because someone on TV said
17:36
it was the next big thing and then next week
17:39
a macroeconomic shock hits and that stock drops
17:42
25 percent, your immediate biological response
17:45
is sheer panic. Because you have no idea what
17:47
you actually own. Right. You have no anchor.
17:49
So you just sell at the absolute bottom. But
17:52
if you fundamentally understand why you own it,
17:55
if you know they have a Fortress balance sheet,
17:57
reliable recurring revenue, and a product people
18:00
buy even during recessions, you have the conviction
18:03
to hold through the volatility. You might even
18:05
use the drop to buy more. Exactly. Behavior specifically
18:09
avoiding panic selling drives long -term financial
18:12
outcomes far more than stock selection ever will.
18:15
And on the flip side, we have to acknowledge
18:17
what technical analysis provides better than
18:19
anything else, which is risk management. Right,
18:22
the stop losses. Yeah. We talked about how the
18:24
pure fundamentalist can stubbornly ride a dying
18:26
company all the way down to zero because their
18:29
ego is tied to a spreadsheet. Well, the technician
18:31
doesn't have that ego. They just follow the chart.
18:34
Exactly. When they buy, they decide in advance
18:37
exactly what price proves their thesis wrong.
18:40
having an explicit predefined exit plan, knowing
18:44
when to take a small paper cut before it becomes
18:46
a fatal wound that is a massive advantage in
18:49
capital preservation. We also really need to
18:51
contextualize where you apply these tools. Efficiency
18:54
isn't just a binary switch. It's a spectrum.
18:57
Oh, for sure. Like if you are analyzing a massive
18:59
global tech conglomerate covered by 80 full -time
19:03
Wall Street analysts owned by every major sovereign
19:06
wealth fund and trading millions of shares a
19:08
millisecond. price is incredibly efficient. Yeah,
19:12
finding a hidden fundamental bargain there is
19:14
like trying to find a hundred dollar bill on
19:16
the floor of a crowded train station. It's already
19:18
been picked up. Exactly. But if you go to the
19:21
far edge of the spectrum, say, a microcap mining
19:23
exploration company listed on a junior exchange
19:26
covered by zero analysts with barely any daily
19:29
trading volume, that sandbox might be highly
19:32
inefficient. Oh, absolutely. The efficient market
19:34
hypothesis breaks down pretty fast in the dark
19:36
corners of the market. Right. But playing in
19:38
that sandbox means you are dealing with treacherous
19:41
liquidity, massive bid -ask spreads that immediately
19:44
eat your capital, and a fundamentally higher
19:47
risk of the company just entirely disappearing.
19:50
The inefficiency exists, sure, but you pay for
19:53
it with extreme risk. Which basically brings
19:55
us to the reality of how modern professionals
19:57
actually operate today. The dogmatic purists.
20:01
You know, the fundamentalist who absolutely refuses
20:04
to look at a chart and the technician who refuses
20:06
to know what the company even sells. They're
20:09
largely a myth today. Mostly, yeah. Most successful
20:12
practitioners use a hybrid approach. They use
20:14
fundamental analysis to decide what to buy, ensuring
20:16
it's a high quality business with a strong cash
20:19
flows that won't go bankrupt. And they use technical
20:21
analysis to decide when to buy it. Right. Looking
20:24
for favorable entry points, checking the momentum
20:26
and setting logical stop loss levels to manage
20:29
their downside risk. So what does this all mean
20:31
for your own portfolio? We've explored the fundamentalist
20:35
valuing the business, the technician studying
20:37
the behavioral patterns, and the EMH academic
20:39
arguing the price is already right. The ultimate
20:42
lesson is that you shouldn't torture yourself
20:44
trying to outsmart the collective wisdom of the
20:47
market. No, the structural math proves how incredibly
20:50
hard that is. Instead, focus on the variables
20:53
you can actually control. Keep your fund fees
20:56
relentlessly low. Manage your asset allocation
21:00
between equities and fixed income based on your
21:02
actual timeline. Be hyper -efficient with your
21:05
taxes. All things within your control. And above
21:08
all, build enough fundamental conviction in your
21:11
strategy that you don't panic sell when the market
21:13
inevitably drops. Be incredibly suspicious of
21:17
anyone selling you absolute certainty. Because
21:19
in the financial markets, certainty is the only
21:21
thing that truly doesn't exist. You know, I want
21:23
to leave you with one final provocative puzzle
21:26
derived from the paradox of the efficient market
21:27
hypothesis. Lay it on us. We established earlier
21:30
that market efficiency relies on active analysts
21:33
fighting tooth and nail to find bargains, right?
21:35
But think about the macro trend happening right
21:38
now. as more and more everyday investors look
21:40
at the data, except that the market is mostly
21:42
efficient, and pull their money out of active
21:45
funds to buy passive index funds. The pull of
21:49
active fundamental analysts doing the hard work
21:52
of pricing assets is slowly shrinking. Oh, wow.
21:55
I see where you're going with this. Yeah. If
21:57
that trend continues and passive indexing just
22:00
completely devours the market, does the market
22:03
eventually become inefficient again? Is the massive
22:05
success of passive investing inadvertent? hollowing
22:08
out the price discovery engine, creating a landscape
22:12
that is just waiting for a new generation of
22:14
fundamental analysts to arrive and pick up those
22:17
hundred dollar bills left lying on the sidewalk.
22:19
Man, it is a wild thought just two people staring
22:22
at a ticker, one drawing triangles, and one building
22:24
spreadsheets, completely disagreeing with each
22:27
other. Right. But maybe they are the only ones
22:30
keeping the whole machine running for the rest
22:32
of us. Thank you for joining us on this deep
22:34
dive into the mechanics of the market. Keep learning,
22:37
keep asking questions, and don't let the information
22:39
overload win. We'll see you next time.