Does Elliot Wave’s Robert Prechter Know that Stocks are Interests in Real Companies?

“It is critical for an investor to understand that securities aren’t what most people think they are.  They aren’t pieces of paper that trade, blips on a screen up and down, ticker tapes that you follow on CNBC.  Investing is buying a fractional interest in a business….”

–Seth Klarman, in a recent interview with Jason Zweig

This is something that seemingly many have lost track of over the last ten plus years. In the late 1990s and early 2000s, people of the bullish and/or momentum persuasions lost track of the reality cited above in embarking on a buying frenzy in any instrument with a “” in its name.  Now it seems that the very same phenomenon is beholding many with a “perma-bear” persuasion.

Robert Prechter and his brand of Elliott Wave Technical Analysis is at it again.  Recently he made an appearance on Yahoo’s Tech Ticker declaring that the Dow Jones Industrial Average was headed on its way to 2000.  Yep you read that right, Robert Prechter believes that Dow 2k is on its way.  Not too long ago on this blog we asked if “Robert Prechter is certifiably insane” and it’s time to revisit that question.

Many will defend Prechter for having predicted an epic bull market when many were most ominous about the future of equities, and many more commend Prechter for anticipating the risks of a deflationary spiral in the early 2000s.  That being said, in between and since there have been many calls, some right, some not so right, with no real consistency one way or the other.  The real problem, as I see it, is far broader than just Prechter himself.  The problem is that many technical analysts fail to consider the fact that, as Seth Klarman’s point above makes clear, equities “aren’t pieces of paper that trade, blips on a screen up and down” and in fact are a real “fractional interest in a business.”

Do not underestimate this very real fact!  As the March 2009 rally off of lows ensued, I saw many expert “technical analysts” gaffe at the potential for a market rally.  One “expert” trader in particular pointed to Apple (NASDAQ: AAPL) when it was trading around the $100 area and proclaimed that a downside move to $60 was not just likely, but inevitable because for one “there is an unfilled gap and gaps get filled” and for two, on a break of the $120 support there is no level until at least $80 where buyers have stepped in.  Take a look at the chart (the gap is circled in July of 2006):

Does the gap in AAPL really matter to any serious investor?

Now from a purely technical perspective, someone who does not know that Apple in early 2008 held $20/share in cash, 20+% earnings growth, and a fairly modest P/E could easily say “that’s a lower high, about to break support and this next leg down won’t end until that July 2006 gap gets filled.”  Many serious traders thought the next move for Apple would take it into that gap level.  Afterwards, Apple did in fact break the $120 level and spent some time consolidating under $100, but we all know what happened from that point on.

Yes this is one example, and yes, this is the strongest stock in today’s market, but that alone does not change the overarching point: technical analysis in isolation is of little value.  I personally use technical analysis frequently in my investment decisions, but it is never my decision-maker.  Rather it is my guideline for entries and exits in ideas that I really like.  In reality, as one prominent trader, and a personal mentor put it, “fundamental shifts outweigh technicals every time.” Fundamentals are for idea generation, technicals are for timing those particular ideas.

The problem with many technical analysts these days isn’t that technical analysis is bad, it’s this misguided notion that one can look at any chart and determine its course of action solely based on historical price data.  I take particular issue with those who look at historical charts of the S&P or Dow in order to make bold declarations (Prechter cough cough) as to its future path.  If you use history as a guideline, ok, that’s fine, but if you use history as a predictor, then look out.

One reason that is particularly true with respect to the indices is that stock market indices inherently have a survivorship bias.  Why is that?  Well when companies fail or fade from prominence, they are replaced with newer, younger, leaner and faster growing ones.  Out with the old, in with the new.  Today’s Dow is very different from 2007s Dow, and even more different than 1970s Dow, however, if you look solely at a historical chart of the Dow there is no way to know this fact.  With CNBC now showing a flashy screen of Level II quotes, and movies like Wall Street II showing Gordon Gekko sitting at a monitor with Level II’s jumping around, it’s clear that far too many treat technical analysis as some sort of voodoo rather than what it is: one tool out of many in an investor’s arsenal.

Disclosure: No relevant positions.