Using Sell-Side Analysis to Predict the Future for Equity Markets

by: Muditha Weeratunga

In this article I will try to study the ability of using sell-side analysts’ collective recommendations to forecast the future direction of the broader equity market. In an attempt to get an indication of the bullishness/bearishness among sell side analysts, I have compared the total “BUY” recommendations as a percentage of the total recommendations for each stock. Then I have taken the aggregate of this percentage for the overall market. Quite interestingly, most of the time analysts got it wrong. In fact, as I will show later in the article, this bullishness among the analysts can be used as a contrarian indicator to forecast the market direction.

In this analysis, I am using the S&P 500 and FTSE 100 indexes as these two indexes are two of the most covered markets. These indexes are relatively well diversified; hence the performance in one dominating sector will not distort the true picture.

Post the 2003 recession, overall analysts’ recommendations have become less bullish

Looking at the table and the chart given below, it becomes clear that since 2000, the analyst have become relatively less bullish with their calls. Interestingly, the GFC era doesn’t seems to have had a major impact on the analyst view. On average, U.S. analysts were more bullish than U.K. analysts, but the gap is closing.

Chart 1: Analyst becoming less bullish (Click to enlarge)

Table 1: Average analyst recommendations during different time periods.







Post 2003






Analysts were good at following the trend. By overlaying the index performance and analysts' bullishness in a chart, we can get an idea of analysts' performance with the market movements. In both these markets, analysts were good at following a trend. Post-2003, up until the GFC [global financial crisis], the equity markets followed a trend. In both the U.S. and the U.K., analysts managed to track market trends with their recommendations.

Post-GFC, U.S. analysts were lagging with their recommendations in terms of following the market, but U.K. analysts were quick to start following the market.

Chart 2: Post-GFC, U.S. analysts were lagging in terms of their bullishness (Click to enlarge)

Chart 3: Post-GFC, U.K. analysts were quick to pick up to track the market (Click to enlarge)

How good were the analysts in predicting future performances?

Analysts are supposed to advise their clients about the future direction of the market, not to track the market direction with their bullishness. To test the effectiveness in predicting the future direction, I have plotted the succeeding 12 month performance since the day of the recommendation.

Predicting U.S. market returns:

I have looked at the deviation of the analysts’ bullishness from the long term mean (calculated for the period post-2003) to test the success of the analysts in predicting the future. In chart 4, I have plotted the bullishness deviation from the mean against the broader market return during the 12 month period following any given day.

For example, in August 2006, analysts had 55% of their calls as “Buy”. This is a 4% deviation from the long run mean of 51%. Hence in the chart, on the right hand side it is plotted as 4%. In the 12 months following August 2006 (i.e. August 2006 to August 2007), S&P returned a 13% on average. Hence in the chart, on the left hand side, I have plotted 13%

Chart 4: Analysts’ predictions vs. the 12-month market performance in the U.S. (Click to enlarge)

According to Chart 4, there were four instances where the analysts’ bullishness went above the long term average by 2%. In the table below, I have tabulated the market return during these four instances.

Table-2: Peak deviation from the mean vs. market return


Deviation from the long run avg

Mkt return

Mkt return/ Deviation



















On average, analysts had a 3.5% deviation from the long run mean and the 12 months following these periods generated a 2.4% return.

Predicting the U.K. market returns:

I have done the same analysis for the U.K. market using FTSE 100 and the results were broadly similar. There were only two instances (pre-GFC) where the analysts’ bullishness went above the long term average by 2%. These two occasions generated a -14.3% return over the next 12 months on average.

Chart 5: Analysts’ predictions vs. the 12-month market performance in the U.K. (Click to enlarge)

Table-3: Peak deviation from the mean vs. market return


Deviation from the long run avg

Mkt return

Mkt return/ Deviation















Let’s take a closer look at the Post-GFC era. In the following two charts, I have simply plotted the analyst bullishness vs. the next 12 month market returns. As per chart 6, U.S. analysts were most bullish in September 2007. But in the 12 months following September 2007, the market (S&P500) gave -18% returns. U.S. analysts again reached a peak bullishness in September 2010.

Chart-6: Analyst calls vs. the market performance in the U.S. (Click to enlarge)

The U.K. chart also shows a similar pattern. In October 2007, bullishness among U.K. analysts’ peaked and the next 12 months after October 2007 gave the worst performance (Chart 5). Ironically, March 2009 saw the most bearish analyst recommendations in the U.K. post the GFC, and the market (FTSE 100) gave the best results during the 12 months following March 2009.

Chart 7: Analyst calls vs. the market performance in the U.K. (Click to enlarge)

If we go by this analysis, where is the market heading in the next few months? To get a gauge of the sensitivity among the bullishness deviation and the next 12 month return, I have used the 12-month return/ bullishness deviation ratio. In table 4, I have applied this ratio to calculate the target index level in 12 months time since the time of peak bullishness.

Table 4: Target index levels using peak analyst bullishness

Bullishness Peak

Index level

Bullishness Deviation

Hist average 12 month return/deviation

Implied index level in 2011

current index level

pre GFC


pre GFC




















I have looked at two scenarios, one with only pre-GFC numbers and another one with the total data set. There are two clear outcomes:

  1. Both S&P and FTSE should see some sort of weakness in the next few months.

  2. In the U.K. market we can expect a higher risk for a correction than in the U.S. market.

When I consider the other macro events that are unfolding at the moment, the quantitative analysis results fit very much in line. For example, in the U.S., there is a very high possibility that we won’t see any sort of market correction until September 2011. The chances are that once the QE2 ends, the Fed will want to give it few months to see how the economy reacts. At the same time congress will continue to fight over the August 2011 debt ceiling for the U.S. government. Both of these events will create uncertainty among investors and equity markets will struggle to find any direction until these issues are resolved. In my view, September 2011 is a reasonable time frame for that to happen and hence for the market to bottom.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.