Stocks – Demise of Fundamentals

We need to focus on investor behaviour to gain an edge.

The “demise of fundamentals” as highlighted by renowned investor Jim Chanos signifies a growing concern in the investment landscape. Chanos, famous for his expertise in short selling, has pointed out the evolving challenges surrounding traditional fundamental analysis in today’s markets.

What isn’t in full force is the golden age of fundamental investing. Recently we saw a steady procession of overseas investors tell the UBS Australasia and Sohn Hearts & Minds events in Sydney that the combination of passive investing, algorithmic investing, retail investing and momentum trading meant fundamental investing simply isn’t working as it once did.

Chanos similarly acknowledged as much in his letter.

“It is no secret that the long/short equity business model has come under pressure and interest in fundamental stock pickers has waned,” Chanos wrote.

If there’s a lesson from Chanos’ decision to shut his hedge funds, it is surely this. The effectiveness of the traditional approach to investing – finding an undervalued stock to buy, or an overvalued stock to short, and hoping fundamentals eventually shine through – is looking increasingly ineffective.

Shifting Market Dynamics Chanos and other critics argue that the traditional methods of evaluating companies based on fundamental analysis — scrutinising financial statements, assessing business models, and projecting future earnings — are facing unprecedented challenges. The landscape of markets has been reshaped by technological advancements, changes in consumer behaviour, and global economic shifts.

Tech-Driven Disruptions One of the key factors contributing to the erosion of traditional fundamentals is the rise of technology. The emergence of a tech-driven price based analytical focus has triggered company and investor disruption which poses a challenge to conventional valuation models. These companies often prioritise user base and market share over immediate profitability, challenging the traditional metrics of analysis.

Market Sentiment and Speculation Chanos and others emphasize the growing influence of market sentiment and speculative trading on stock prices. In an age of social media, where information spreads rapidly and retail investors hold significant sway, stock valuations might become detached from fundamental realities. The phenomenon of meme stocks and the volatility they generate exemplifies this disconnect.

Financial Engineering and Accounting Practices Another concern raised by Chanos is the prevalence of financial engineering and creative accounting practices. Companies sometimes manipulate financial statements, using techniques like aggressive revenue recognition or off-balance-sheet items, which can distort the true health and performance of a business. This manipulation can mislead investors relying solely on traditional fundamental analysis.

Adapting Strategies Chanos advocates for a nuanced approach that incorporates a broader array of factors beyond traditional financial metrics. Investors and analysts are urged to consider quantitative aspects such as behavioural assessments and measurements. This holistic view helps in understanding the true value and the risks associated with a company or industry.

While the demise of fundamentals might seem an ominous statement, it prompts a necessary evolution in investment strategies. Chanos’ insights underline the importance of adapting to the changing landscape by incorporating a mix of traditional analysis and a deeper understanding of the broader economic, technological, and societal factors shaping today’s markets. The full force of behavioural analysis is descending on stock price movements. Ultimately, this adaptability and a balanced approach could prove pivotal in navigating the complexities of modern investing.

‘The only stock market advice you can trust is the price action’ –

the price never lies

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