Oh no! A cart is headed towards five people. You can pull the lever to divert it to another track, killing a person. What are you doing?
If you don’t think the cart is headed your way, pull the lever shortly after it kills five people, you could be an equity analyst.
If you do nothing because a trolley is a proven lead indicator for several trolleys expected to kill all six people, you could be a market strategist.
Last week we talked a bit about how the balance of bearish analyst forecast updates remains in positive territory for US, UK and European markets, even as strategists warn of a global recession of several years What results is a gap between top-down and bottom-up earnings predictions that’s so wide it doesn’t even fit into Berenberg’s chart template anymore:
As we wrote then:
An equity analyst’s job is to smell the air and touch the ground around their assigned industry so they can get a sense of what’s coming. Above all, they do this by talking to the managers of the companies under their coverage.
When things are going well, this is a very good system. Executives guide analysts to a number that sounds reasonable and then beat it every quarter by 5-10 percent. Everyone is happy. The methodology falls apart during downturns because executives are confident they are taking the right actions to protect profitability, meaning their companies will outperform their peers. Therefore, each analyst has only a Panglossian view of reality. Forecasts stay too high for too long.
Additional evidence for the case against analysts comes from Citigroup strategist Robert Buckland, whose recent bullish flags “have returned to the bullish highs reached in 2000 and 2007, after which global stocks cut in half.”
The measure chosen here is recommendations, not forecasts.
Because analysts are always net positive on stock recommendations, Citi uses a z score which measures the bullish relative to the long-term average. Its plot matches market performance quite well, although the amount of investor activity inspired by sell calls and vice versa is a matter of debate.
Either way, analysts’ and stocks’ confidence in them seems to be on the rise. At least for a while:
That is until we get to irrational exuberance, which is easy to spot in the peaks of 2000 and 2007. Less easy to explain is the burst of over-optimism in the midst of the Eurozone debt crisis, after the which actions deviated; theories welcome in the comment box.
Anyway, the Citi gauge is back to bullish 2007 for all sorts of things. “In no region or global sector are analysts more cautious than they were two years ago,” Buckland writes. “Any investor who is concerned that analysts are currently too bullish should probably be more concerned about the red boxes than the green boxes.”
“The lagged relationship between recommendations and profit forecasts suggests a state of denial at the start of a bear market,” he says. “Analysts remain positive, although they are starting to cut their profit forecasts. They finally cut their recommendations, but it takes time.”
An obvious response is to argue that sales recommendations are always too compromised to be useful (which it could be true), and strategists are always shady by nature (ditto). There is also the complication that Mifid II changed the incentives for both analysts and IB clients, meaning that the period after 2018 may not be directly comparable to what happened before.
Yet. By placing the three-month swing in earnings revisions above the buy/sell ratio, Citi concludes that European and Japanese utilities are less likely to disappoint, because their numbers are they update reluctantly. In the opposite quadrant is . . . almost everything else: