Getting It Wrong: Analysts Contribute to the Current Downturn

Incorrect forecasts by brokerage analysts are contributing to the current downturn in the equity markets.

Energy, finance and technology are the three biggest components of the large-cap index, and analysts have been constantly revising their estimates on oil and banking companies. Last week's miss by Research in Motion (RIMM) and cautious guidance by Oracle (ORCL) raised the possibility of technology earnings being a bit light in the second-half of the year.

The Oil Gush Keeps Getting Higher

Exploration and production companies continue to account for a disproportionate number of positive earnings estimate revisions, and if the International Energy Agency's [IEA] pronouncement proves to be correct, profits could continue rising for several years.

Regular readers of this column know that I've been pounding the table on companies within the upstream side of the oil business for quite some time, due to the trends in earnings estimate revisions.

Consider these statistics:

• Companies within the Oil & Gas-U.S Exploration and Production group have received 5x more positive estimate revisions than the analyst coverage would dictate¹.
• Out of the 220 stocks on the Zacks #1 Rank ("Strong Buy") List, more than 10% are classified in Oil & Gas-U.S Exploration and Production.

The reason for the bullishness is that oil continues to command prices far above what analysts expected, even relative to their revised forecasts. As crude becomes more expensive, oil E&P companies like Cabot Oil & Gas (COG), EOG Resources (EOG) and Noble Energy (NBL) are able to earn more money.

According to the IEA, the bullish cycle for these companies could continue for several years. Yesterday, the agency's executive director, Nobuo Tanaka, predicted that "supply constraints, refinery limitations and continued demand growth in key emerging markets will maintain pressure in the market over the medium term".

Tanaka believes that current and planned infrastructure will not be enough to offset the rising demand from emerging markets. As a result, oil will remain expensive with any decline over the next 1-12 months being followed by a rebound.

What Is On The Banks' Books?

Just as brokerage analysts have continuously been wrong about forecasting oil company profits, they have also been wrong about predicting just how much bad debt banks are going to write off this year. As a result, national and regional banks account for more than double the number of downward earnings estimate revisions they should otherwise command.

The fallout from the housing slump and adjustable rate mortgage resets is being compounded by a sluggish economy and rising energy prices. Banks are shooting themselves in the foot by lacking the proper staff to handle short sales and renegotiate terms with current borrowers.

Then there are the tightening credit standards. Home equity lines are being cut, which curtails a source of revenues. Mortgages are harder to get, which means lower origination fees. Credit card limits are being cut and interest rates are being raised simply because of what a consumer purchased with his credit card. (A story on NPR's Marketplace last night warned that buying retread tires could cause a card issuer view to a consumer as having a higher risk profile.) Very few companies view not doing business as a profitable strategy, but that is essentially the path many banks are on.

The result is a complex problem that is unlikely to face a resolution until next year.

To be fair, many banks view risk-adverse strategies as a short-term necessity. The majority of banks and thrifts don't know the extent of the write-offs they will be forced to take over the 6-12 months. As a result, it has been impossible for the brokerage analysts covering companies such as Washington Mutual (WM) or Zions Bancorp (ZION) to project earnings with any accuracy.

Those who followed the Zacks Rank and paid attention to the downward revisions in earnings estimates would have avoided the large drops posted by financial stocks - and would continue to be wary of those now.

Where Is Technology Headed?

The third main component - technology - has been a mixed bag. Mobile computing, data storage and overseas business have been sources of growth. Semiconductors have struggled with an overall lack of pricing power, though the actual impact has been somewhat company specific.

The trend towards mobile computing and previous surprises created the expectation that Research in Motion would beat fiscal first-quarter forecasts handily; instead the company missed. Given a warning from Sony Ericsson about weakening demand for mid- to high-end handsets, this may be an issue solely related to handsets. The new, lower priced iPhone could be stealing some market share and many individuals may be deciding that their current phones work just fine. Given that music, video and texting capabilities have been available on many mobile phones for quite some time, the extra benefit of a new phone is questionable.

Oracle presented a conundrum, however. The company's fiscal first-quarter guidance was fractionally below what some were expecting. Though the consensus estimate has stayed unchanged at 26 cents per share, four brokerage analysts trimmed their projections within the past seven days.

The worry is that if ORCL is cautious, will other tech firms be cautious as well? Current trends in earnings estimates are inconclusive. Full-year forecasts for Cisco Systems (CSCO), Hewlett-Packard (HPQ), IBM (IBM) and SAP (SAP) are unchanged. For the entire technology sector, there are slightly more positive revisions than negative revisions, but the margin is not big (283 estimates revised up versus 222 estimates revised down).

We typically do not see many estimate revisions this time of year, so it would not be valid to characterize the lack of revisions as signaling uncertainty on the part of brokerage analysts. For traders looking for confirmation of a trend, however, the silence is deafening in the current market environment.

Investors need to view the silence for what it is, a non-event. A Zacks #3 Rank simply implies a stock should perform inline with the broader market over the short-term. Long-term investors will need to continue to monitor their stocks, but should not alter their weighting in technology without seeing further information first. This said, never hold onto an investment if doing so keeps you up at night.

Comments

[squashnut]

The banks and investment banks (not much difference after repeal of Glass-Steagall) don't know themselves how to value what's on their balance sheet and off so the analysts don't have much chance. Quite comical to watch them all downgrade one another last week. Read "Trillion Dollar Meltdown". Even Goldman says it's more than that now.

[User 26737]

Totally ........ analysts ........ support certain stocks in/on the news while they are shorting .......... kill stocks ..... then buy! Average joe is getting whiplashed by the analysts. Cramer says buy oi, week later sell oi. Analysts play a game with average joes money and laugh all the way to the "bank".........

[notsosmart]

i keep saying-dont believe anybody re anything.all have their own agenda & are laughing on the way to the bank.this all is no longer a business but a game.its a vegas style situation only a little slower.

[quetzalcoatl]

I find it rather curious that one brokerage house downgrades another while a bank down the street downgrades its neighbor. Then there is the contest between banks and brokerages downgrading one another. I find analysts opinions to be bewildering. All the while they are recommending stocks as being undervalued and as great buys the stocks are plummeting into the abyss. How much of all this pseudo information is agenda driven?

[notsosmart]

everything on tv or the net is agenda driven.when the dumb-dumber americans begin to think for themselves things may change. just look at our presidential options. talk about a decline of a once great nation.ok call me unpatriotic cause i say it as i see it.

[paultaut]

So, when analysts are pushing stocks up like they did in the Tech. Bubble that was okay because stocks were going up. But now, its not okay for them to be negative because stocks are going down.

Everyone wanted them to be more truthful, yet, now you want them to shut up.

I suggest you find all the Bullish Analysts, make a list and at the end of the year, see how much money they made for you.

IMHO, I expect to see the DOW approach 9,000 by years' end. It will be that high because of the commodity portion in it. That's only another 20% drop.

Meanwhile, the S&P...... look for the Low's of the decade to be revisited.

I started investing almost 40 years ago. The S&P at 15 times earnings was considered to be very overpriced. After time of the "Nifty Fifty" Bubble, it took the Dow a decade and 12% unemployment to finally start a sustained move to the upside. The Dow was trading at Book Value.

Bubbles top out when there is complacency, Commodities are still "climbing the Wall of Worry".

"Blood in the Streets" was another phrase used as the time to buy stocks. That aspect is yet to come for the Financials. I will buy Citi when it drops to $8.00.

[Stockaccumulator]

Nice article, but one stock the analysts will have it right in the very near future: (SOL) Renesola is an amazing buy for first thing Monday morning ... all the analysts actually love SOL...

Even Zacks published this (see below article) 7 trading days ago about Renesola (SOL), when the price was bouncing around at about $20.

Zacks Rank in Industry 1 of 44... the best of all solars. Thats number one...

See Zacks' site.

This in addition to Investors Business Daily June computer ranking of SOL as the 4th best company (not just solars but the whole world, every company) to invest in... and in addition to Piper Jaffray's amazing careful on site research on SOL.

Piper Jaffray's article in June practically audited SOL, and its clean balance sheet, and they love it. They don't put their name on just any company.

Last week's drop was clearly a case of throwing the baby (amazing SOL) out with the bathwater to raise cash to feel good before the July 4th weekend... No news on SOL, just bullish: New rediculous cost of oil, and local and national governments worldwide jumping on the Solar bandwagon...

Note that SOL actually sells to other solars, and has a unique method of production and supply, recycling for creation of its product... a unique process and company.

I trust all three combined, Zacks, IBD, and Piper Jaffray.

Read this quote from Zacks last week:

"Through its history, ReneSola regularly adapted to changing market dynamics. The company is aggressively ramping up its polysilicon and solar wafer production capacities. Going forward, increased captive generation of polysilicon will improve its cost structure and enable wafer capacity expansions. Globally, rising solar wafer sales, along with escalating crude and long-term supply agreements, should collectively generate significant earnings growth. Buoyed by these positive factors and
impressive results, SOL increased its 2008 production
output and sales guidance. Accordingly, with a
bullish outlook and an attractive relative valuation, we initiate coverage of SOL with a BUY recommendation and a six-month target price of $24.25, representing 27.2% upside potential."

Note: today, at $13 SOL upside would be perhaps 40% ... Zacks published this above article 7 trading days ago when SOL price was much higher... other analysts have targets of $40, some at $55...

Time to run to your laptop and buy SOL fast...

[fireball]

notsosmart. you seem pretty smart to me. when hillary was still clinging it was like the mountain dew tug o war commercial. different flavors but all the same brand. still i retain hope that americans will wake up.

[galewhitaker]

I believe that that the analysts have it wrong but I think they are way too optimistic. I think we are in the peak oil death spiral where people stop driving and flying, forcing huge layoffs which domino those who depend on auto/airline workers for their livelyhood. I don't think your average stock broker has a clue how much trouble is going to be caused by skyrocketing oil prices.

[paultaut]

It really comes down to this.

Look at the Major Players in the Industry, like MER.
They have taken major hits.
WHY aren't insiders Buying?

[messy]

Based on your wonderful CITIGROUP EXPERTS....i have a question.
Which do you think will go bankrupt first UBS OR Citigroup, as for me its truly a tossup?

[analyst]

It is fairly common to see analysts slammed with incompetence when the market downturn hits.
Truth is, some of us are doing an honest job. Macro conditions deteriorate, and we adjust our assumptions. I have been doing just that over the past six months, and clients who listened greatly benefited.
Don't forget that tech is, at least for the consumer side of it, purely discetionary consumer spending and, as such, will definitely be affected by the current macro environment. For those that depend on corporate spending, same applies. The situation may be somewhat different (but not necessarily better) for those that depend on the capex of telecoms operators. In any case, thinking that the relation between tech and oil prices / housing crash is tenuous is rather naïve.
That said, some valuations in tech seem to me rather attractive after the current correction, and certainly more long-term buys abound in techland than among over-hyped commodity plays (and yes, solar is one of them, sorry stockaccumulator, I have met many of your peers roughly eight years ago in tech!)

[muley101]

What a great time to be a day trader. Enjoy it while you can.