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We have previously written about the optimism bias of equities analysts, illustrated nicely by this chart:
But the McKinsey study that provides the graph also notes two instances in the last twenty-five years when the situation changed and analysts actually became too bearish:
Moreover, analysts have been persistently overoptimistic for the past 25 years, with estimates ranging from 10 to 12 percent a year, compared with actual earnings growth of 6 percent. Over this time frame, actual earnings growth surpassed forecasts in only two instances, both during the earnings recovery following a recession.
Barry Ritholtz, after making the above observation, links to a Bloomberg article that suggests we might now be seeing this kind of unwarranted pessimism:
For the first time since at least 1997, fewer than 29 percent of ratings for stocks covered by brokerages worldwide are "buys," according to 159,919 recommendations compiled by Bloomberg. Analysts are turning more pessimistic even as they push up estimates for profit growth among Standard & Poor's 500 Index companies to 36 percent, the highest since 1988. …More than 54 percent of ratings for companies in the U.S., U.K., Japan and Brazil are "holds," the highest level since Bloomberg began tracking the data in 1997. While the proportion of "sell" ratings in the U.S. has fallen to 5.1 percent, half the level of 2003, the total combined with "holds" reached a record 71 percent last month, the data show.
"A "?neutral' usually means historically a "?sell,'" said Kevin Rendino, a money manager at New York-based BlackRock Inc., which oversees about $3.2 trillion. "Ratings chase stock prices. When everyone becomes risk averse, they don't want to stick their necks out."
And here is how Ritholtz explains it, making use of another McKinsey chart:
Why so many bearish stock calls from equity analysts? Fear of a double dip. Slowing growth. Concern that joblessness will weaken consumer spending. Uncertainty. Negativity on the economy. Credit issues. Lack of economic catalyst.
In other words, all of the general economic concerns trumpeted in the media each day "” that these analysts have precisely zero expertise in identifying, anticipating and responding to. In fact, most stock analysts would have a hard time dissecting BLS employment data or understanding how GDP is calculated. Its outside of their roundhouse.
Historically, analysts typically "lag behind events in revising their forecasts to reflect new economic conditions." A McKinsey study found that analyst forecast error is too bullish "” except during downturns, when it is too bearish. Actual earnings from S&P 500 companies "only occasionally coincide with the analysts' forecasts."
As the chart below shows, most of the time the analyst community is too bullish by double "” they expect earnings growth of 10 to 12%, compared with actual earnings growth of 6%.
However, the earnings recovery following a recession "“like now "” has analysts under-estimating earnings.
So in spending too much time at the proverbial party, analysts tend to show up late to the occasional funeral.
Truthfully, we have no view on what stock prices will do next or whether the market is undervalued.
But we’ll just inject a bit of skepticism by pointing out that 1) By at least one (very long-term) metric, stock prices remain above historical averages, 2) You can still find plenty of analysts who remain bullish, 3) The profits recovery may not last, and 4) In the instances above when analysts have become too bearish, it hasn’t been by much.
Not constructive, we know, but you’ll have to draw your own conclusions.
Related links: Are Wall Street analysts contrary indicators? – The Big Picture Sell Signal on 36% Profit Increase Has Analysts in Math Denial – Bloomberg Analysis: High end of S&P 500 forecasts looks unlikely – Reuters
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