Analyst Sentiment Finally Net Bullish: Is it Time to Bail?

For the first time since April of 2007, the number of profit forecasts that have been raised in June was greater than the number that were lowered, according to data collected by JP Morgan Chase (JPM). There were 896 raised forecasts in comparison to 886 lowered, not a wide margin but net bullish nonetheless. This comes on the heels of first quarter earnings, where analysts were shown to be overly bearish. For the second quarter, the scenario has thus far played out the same way, with some 75% of firms beating the Street’s estimates in second quarter reporting. Wall Street estimates had fallen extremely hard during the second half of 2008, at the fastest pace on record, and analysts are just now starting to bring them back up.

In general, we view analysts estimates as a benchmark and don’t believe that they should receive too much importance. However, market observers have seen the lift that one analyst’s changing opinion can have on a stock. For example, look at what happened when Meredith Whitney correctly predicted the earnings blow out by Goldman Sachs (GS) a day prior to their reporting. The company did not report a single number on that day, but the fact that a superstar analyst was bullish on the company lifted the stock nearly 6%. As this example illustrates analysts can and do move the market, and the fact that analysts as a group are becoming more bullish could have a substantial effect on the broad market. According to Bloomberg, consensus Wall Street estimates for full year 2009 profits of S&P 500 firms has increased to $74.55 from $72.54 in May. The consensus view of analysts puts the forward looking expected price to earnings multiple at about 13.13x. This not a rich multiple when compared to the 50-year historical average of 16.54x. If analysts continue to boost estimates for the full year the this valuation metric will likely continue to look attractive.

Wall Street was left looking much too bullish coming into the recession and were forced to rethink their estimates in light of a credit market that had seized up and very difficult environment to forecast. They dropped profit expectations at the fastest pace ever, with profit estimates lowered on four out five revisions in October 2008. The results have shown that analysts quarterly figures have been too low for the past two quarters, which adds pressure for analysts to lift those estimates as even more encouraging macroeconomic data becomes available (such as today’s new home sales data). As analysts are getting demonstrably more bullish, are they getting ahead of themselves? With S&P 500 earnings currently pegged to hit $74.55 for the year, analysts are already predicting a 25% rise from last years’ predicted 2009 earnings figure of $59.80. That represents the largest increase in earnings projections in 14 years, and more upward revisions are likely on the way.

Looking at consensus analysts estimates and their trends is an inexact science because they are often proven to be on the wrong side. Recently, we have seen analysts too bullish leading into the downturn, and too bearish as the market has recovered some of its losses. Some analysts are surely better than others, but overall recently individuals would have done better investing counter to the trends in analyst sentiment. So far in the second quarter, companies have been coming up a little light on revenue, and yet beating earnings. Which means analysts have underestimated the amount of cost cutting going on in corporate America. This is a completely rational thing for companies to do right now, but it does not suggest an overly bullish stance on the market from our view. If analysts continue to raises estimates to avoid being characterized as overly bearish again, then we would not be the least bit surprised to see them come up on the wrong side of the trend again in the second half.

Original post

Comments

[WhoisJohnGalt:]

The nature of these analysts is sell-side, and as one SA article pointed out (submitted about a month ago, I apologize for being unable to locate it), despite sour market performance during Q4 2008 and Q1 2009, they were stubborn to move to outright "sell" recommendations. Instead, most stocks were downgraded to "hold" or positions that still imply future gain. Remember that these analysts act like used car salesmen, showing off the bells and whistles to hide what is relatively worse under the hood.

Jul 27 04:28 PM

[puravidavid...:]

Analysts are part of the herd. As the mood's improved from the early March lows, so have earnings' forcasted.

The market will correct any excessively early optimism with another leg down, unless the credit fundamentals improve significantly and sooner than anticipated.

I suggest not betting they will, with the specter of the deflationary damage to be done to collateral values with the continued growth of consumer and commercial insolvency.

Jul 27 06:47 PM

[pslater:]

The only problem with this logic is the use of 'operating' EPS instead of 'as reported' EPS. S&P's website shows the following estimates 2009 and 2010:
2009 operating EPS = 61.71. 2009 as reported EPS = 29.97
2010 operating EPS = 74.01 2010 as reported EPS = 37.21

For all these estimates consider that
1) they are brought to you by the same people who missed last year by several orders of magnitude

2) the historical (quarterly since 1988) average differences between operating and as reported EPS has been between 8% (median) and 13% (average). The 2009 and 2010 estimates reflect differences of almost 50%!

While the P/E ratio of about 13 is appropriate given the current BAA bond yield of about 8%, the EPS values you would apply to arrive at a 'fair value' for the S&P have to be significantly below the operating estimates.

Jul 27 06:55 PM

[LilBob:]

I'm cautiously optimistic at this point. If an improving stock market leads to greater confidence in endowments and a resurgence of hiring in the non-profit sector, and as a result of that we start to see an increase in consumer spending, then we may start to see our way out of this recession. To me these numbers by themselves don't mean anything, what really matters is if these news stories are enough for university, hospital and other non-profit administrators to feel confident enough to give the nod to HR.

Jul 27 09:47 PM

[cameroni:]

What the markets do as opposed to what is actually taking place in the broad economy just leads everyone, including analysts, to the wrong conclusions.

Markets are still thinly traded and the big players have taken the lead in driving prices. Does that suggest a bullish outcome? When I look at figures coming out of Europe for housing, unemployment, GDP growth (real and imagined), their credit crisis etc and then try to apply that experience back to North America I am left with only a single conclusion.

That conclusion is that most of the major Western economies are in a sharp decline and only more stimulus will rescue all of us from the deflation that is on our doorstep. I am talking about Italy, Greece, France, England, Ireland and even (god forbid!) Germany. Of course stimulus will also harm us through the resulting inflation.

The stunningly optimistic IMF growth(?) forecasts hardly do justice to the severity of the reality on the ground. Can any of it be believed anymore? The EU is headed to hell in a hand-basket. Hardly an omen of strength for the North American economies.

So is it time to get bearish and bet against the markets?

Not on your life! I expect a very strong surge in the coming weeks, a Dow that exceeds 10,000 and a lot of new money jumping on the bull train. Just know that I also expect it all to end very, very badly.

So stay alert.

Jul 27 11:02 PM