Finance Assignment

Fundamental and Technical Analysis with The Global Financial Crisis

The Global Financial Crisis has been discussed more than any other economic event. This affair has been one of the most negative episodes in history due to its impact on the world’s economies and on such a very large population of its people. The causes of the Global Financial Crisis have been attributed to a variety of factors. Fundamental and technical analyses, in parallel importance, are two of those contributing factors. In this analyses, each analysis participator attempts to prove the usefulness of his or her principle, especially after the Global Financial Crisis because people want to be clarified what leaded them to that crisis. Both fundamental and technical analyses seek to identify future prices of stocks on the stock market and which one was responsible for the Global Financial Crisis. This essay will provide the overview of the Global Financial Crisis and mainly focusing on the reasons why fundamental analysis is not literally responsible for the Global Financial Crisis.

Fundamental analysis is the investigation of obvious and unobservable economic factors that may have an impact on the operations of a company. Like other types of analysis, it aims to predict the future prices of stocks. It also identifies the expansion of an economy and estimates which stocks are undervalued and which are expected to grow (Sharma and Preeti 2009). Kothari (2001) explains that according to fundamental analysis, a firm’s value calculated from engaging financial reports for individual companies with economic factors that may influence that company. Fundamental analysis generates this result by looking at companies’ financial statements, announcements and other available resources. Fundamentally analyzing the company’s information and examining its economic data leads often to the right prediction about stocks in the future (Abarbanell and Bushee 1997). However, Waldron and Seng (2005) believe that the purpose of fundamental analysis is a “reduction of risk in decision making”. They disprove of the idea that abnormal returns cannot be continuously gained.

It is argued that fundamental analysis is a means of gaining money from a sinuous channel rather than from a straightforward channel, as stated by Penman (cited in Waldron and Seng 2005). Although, there is no single method of fundamental analysis, according to (Sharma and Preeti 2009), fundamental analysis is made up of two processes: distinguishing between mature and young firms and studying shares that are expected to grow. There are two common methods for conducting fundamental analysis: a "top down" strategy and a "bottom up" strategy. A “top down” strategy is a methodology of analyzing company’s operations and its expected future activities then moving to an analysis of the entire macroeconomic of the country in which that company operates. Conversely, a “bottom down” strategy starts from the opposite end, narrowly analyzing the macroeconomic structure, governmental policies and the company’s environment until it reaches the investment strategy of the company. In a given macroeconomic structure, it may be that some shares adequately reflect the value of their companies, but the company value will be negatively affected by the global financial crisis if the whole economy has an inefficient market form. Consequently, in the event of economic recession, almost all industries and companies will be negatively impacted. Fundamental analysis brings a clear advantage for investors because it allows them to base their decision making on clear result.

On the other hand, technical analysis focuses on marginalizing the market efficiency hypothesis (Neftci and Policano 1984). After the Global Financial Crisis, a large number of market participants disputed this hypothesis and attempted to remove it from the market (Easton and Kerin 2010). In short, technical practitioners believe that the history repeats itself, so a market’s historical and present data are the main resource used to predict the market’s future movement (Brown and Jennings 1989). Technical analysis aims to shape the trends of a market which are shown by the direction of economy forces. Identifying trends is the cornerstone of technical analysis because trends’ direction is unsystematic. Also, because of “high leverage, high liquidity and low brokerage costs permit quick trading profit” at the short term, technical analysis has become very common, particularly in the futures market (Austin 1989). Brown and Jennings (1989) add that obtaining information from past and present prices increases the opportunity of having a relatively accurate expectation. However, technical analysis ignores some factors that should be analysed; as a result, the predictions of future prices are inadequate (Austin 1986). Technical analysis in reality takes less time to perform than other strategies, so it is preferred by some because it is not time-consuming, especially for the short run, and when the results are needed quickly.

Nevertheless, technical analysis has some weakness because of behavioral actions, which can be taken into account by practitioners if there is a widely -spread conflicting information. Strand (2007) states that technical analysts attribute a price’s movements to people’s interactions with the market, so he argues that technical traders are able to forecast future prices when they study and analysis behaviors. Austin (1986) specifies one of the limitations of technical analysis, which claim this statement. That is technical analysts rely on announced information when this information is controlled by professional practitioner. Thus, studying traders’ behaviors might help in expecting the trend but it also there are professional traders who are difficult to predict their actions. Furthermore, technical analysis helps in making profit for a short period of time, but it is hardly ever to work for the long term.

The following two examples will show how both fundamental and technical analysis work in the event of the Global Financial Crisis. The two examples has be taken from the Australian stock market. Firstly, the chart 1 shows the movement of prices in the Australian economy in general.

Chart 1:

( $4857 ) ( $3690 ) ( $6434 ) ( $6297 )

http://au.finance.yahoo.com/

As can be seen, a large drop occurred in early 2009, a result of the Global Financial Crisis that shocked the world. Consequently, firms’ prices went down because they were involved in the economy.

The first example is Commonwealth Bank (CBA): Chart 2

( $56 ) ( $29 ) ( $59 ) ( $49 )

http://au.finance.yahoo.com/

The second example is Westpac Bank: Chart 3

( $25 ) ( $17 ) ( $49 ) ( $47 )

http://au.finance.yahoo.com/

By looking at the Charts 2 and 3, it can be seen that the shares prices of the Commonwealth Bank and Westpac Bank decreased in the trend, following the trend of the Australian economy because traders were exposed to the panic news and all public information that time. To clarify this point, those three trends will be compared to each other in one chart, Chart 4.

The combination of three shares: Chart 4

http://au.finance.yahoo.com/

The green line represents the all ordinaries share price.

The blue line represents the Westpac share price.

The red line represents the Commonwealth share price.

The chart illustrates what occurred during the Global Financial Crisis. Traders and technical practitioners became a target in news reports around that time, which led to increase panic amongst them. This derived them to rely on their emotions on their decision making. Fundamental analysis has an upward trend during its analysed years while technical analysis predicted the markets’ direction as being a head and shoulders curve. Chart 5, below, clarifies the reason behind excluding fundamental analysis from being responsible for the Global Financial Crisis.

Chart 5

The black line in Chart 5 demonstrates the expectation of fundamental analysts. Fundamental analysis does provide reasonable returns but it does not provide the best return usually. Sometimes, the returns on shares are high when the expectation of returns, according to fundamental analysis, is much less. This is because fundamental analysis calculates the intrinsic value of a company, while in reality the company’s share may be traded in overvalued prices. In contrast, the gap between the fundamental curve and actual trading in late 2009 and early 2010 is attributed to technical trading being done at that time. Moreover, this period is considered to be a short term according to fundamental analysis. Investors are meant to gain benefits from fundamental analysis in the long run.

Table 1