Tag Archives: investment performance

where is the stock market headed?: Wall Street strategists vs. analysts

May 13, 2013 By in Industry Analysis, Investment firms, securities markets, sell-side analysts vs. strategists, stock market, using research Tags: , , , , , , , , , , Leave a comment

 Factset:  what Wall Street thinks

Last week I got a press release from Factset, a financial data collection and analysis service, on the topic of where the S&P 500 is headed over the coming twelve months.  The short answer from Factset:  brokerage house analysts think the market is going up a little bit, strategists think the market is going down–again by just a touch.

I’m going to write about this over the next few days.  My short answer:  if history is any guide, neither outcome is likely.  The market seldom drifts along.  It either goes up a lot, or down a lot.

strategists vs. analysts

Who are these people?

First of all, they’re both sets of “researchers” who work for brokerage houses.  Now, they don’t call brokers the “sell-side” for nothing.  The number-one job of any sell-side researcher–analyst or strategist–is to persuade customers to do their trading business with their firm.  In other words, they’re primarily salespeople.  That’s important because it means that at least to some degree they both tailor what they say to fit what their buy-side audience wants to hear.

strategists

Strategists are typically economists or statisticians by training, although they are also sometimes former portfolio managers (snide pms would probably say failed portfolio managers).

Strategists normally work “top down.”  That is, they use data about the macroeconomy to make forecasts about GDP growth and  the course of interest rates.  They then derive expected future earnings growth for the overall stock market and the price earnings multiple at which they think the market will trade.  That gives them a forecast of the future stock market price.  For the S&P over the next year, Factset says the strategists’ consensus is down, but my less than 10%.

Based on their analysis, strategists also recommend sector- and industry-based portfolio structure.  In conjunction with analysts, the may also suggecst individual stock holdings.  They may also help set policy–like the official forecast of the oil price–that analysts more or less adhere to in making their company earnings forecasts.

Strategists are normally much more conservative than sell-side analysts.  Their earnings growth projections are almost always lower than analysts’.  Clients occasionally permit strategists to be bearish, and–as is the case now–to say the market is headed south.  But a prolonged bearish tilt is almost like buying a ticket for the unemployment line.

analysts

Analysts are specialists in specific industries or economic sectors.  They may have academic training in engineering or other subjects pertinent to the industry they cover.  They may have worked in the industry, often in strategic planning or M&A.  They’re invariably deeply knowledgeable about company financials and about the competitive dynamics of their coverage. They often also have privileged access to the top management of the firms they analyze.

That access usually comes at a price.  Analysts can come under considerable pressure not to deviate–either up or down–from the official earnings guidance announced by these firms.  A “sell” recommendation can sometimes trigger a violent reaction from the company in question.

Many investors–childishly–don’t like to hear bad news about the companies they own.  At the same time, the analyst won’t earn much if he doesn’t have good things to say about at lease some firms in his industry.  As a result, analysts tend to err very substantially on the side of optimism.  They turn bearish, even for a short time, at their peril.

year-ago predictions

Industry analysts make projections of earnings growth and set stock price targets for the companies they cover.  They don’t make projections for the S&P.  Factset gets an implicit analyst forecast for the market by aggregating the analyst projections for each company in the S&P 500.

Getting a strategist forecast is much more straightforward.  Factset just takes a median.

Anyway, in April 2012 the implied analysts’ forecast for the S&P was much more bullish than the strategists–at +11.9% vs. +2.6%.

No surprise there.

What is a surprise (“shock” may be a better word), however, is that the analysts were a lot closer to the actual S&P 500 results of +13.8% (capital changes only).

year-ahead projections for the S&P

That’s tomorrow’s topic.

what is a “long-term hold”?

April 30, 2013 By in Getting financial advice, long-term hold, Portfolio management, Trading Tags: , , , , , , Leave a comment

I was listening to radio news yesterday morning when a commentator from the Wall Street Journal  said that many brokerage house analysts are beginning to recommend both Amazon (AMZN) and Apple (AAPL) as “long-term holds”.

What does this mean?

Well, it’s not a compliment.  It’s a way saying “sell” while not putting the word in print.

Why would an analyst be so indirect?    …because if his recommendation on a company’s stock  is “sell,” then the company in question is likely to deny him access to company information, refuse to return his phone calls, decline to appear at conferences he organizes (see my post)  …and do any other stuff it can think of to hurt his career.

Extremely petty, it’s true.  But it happens.  At least with the “hold” recommendation the analyst has a shot a plausible deniability.  He can say to the CEO or CFO that the company is so spectacular that its stock is temporarily overvalued.  All his recommendation is meant to convey is that investors should wait for a slightly lower entry point.

Of course, that’s not what “long-term hold” means.  It’s broker-speak that can be broken down into two parts:

–”long-term” means there’s absolutely nothing attractive about the stock in the short term–meaning the next year or so.  At best, the stock will be dead money.

–”hold” means the stock is not a “buy.”  Over the time frame specified, the stock will likely move in line with the market.

Therefore,

–”long-term hold” means the stock in question is dead money in the short term and, in addition as far forward as the mind can imagine there’s no reason to think the stock ever has a chance to outperform the market.

So, although the term sounds innocuous, in practical terms there’s no worse recommendation than this.

Of course, we can take the discussion one step farther and ask whether analysts’ recommendations have any predictive value.  My take:  analysts typically know a lot about the companies they cover and the industries they’re in.  Only a very few know much about how the stock market behaves.  A lot of times, their recommendations are lagging indicators.

I’ve updated Current Market Tactics: price action this week has made me a bit more cautious

April 17, 2013 By in Constructing a Portfolio, Current Market Thoughts, Recent Market Action, Technical Analysis, Trading Tags: , , , , , , Leave a comment

I’ve updated Current Market Tactics, based on recent price action of the S&P 500.  If you’re on the blog, you can click the tab at the top of the page.

why professionals use the S&P 500 as a benchmark, not the Dow Industrials

March 6, 2013 By in Constructing a Portfolio, Dow vs. S&P, Portfolio management Tags: , , , , 2 Comments

the Dow at an all-time high

Yesterday, the Dow Jones Industrial Average reached an all-time high, signalling a recovery of the index past its previous, pre-Great Recession peak.  This is certainly good news psychologically, since the Dow is a very widely recognized name.  And any report that puts the downturn behind us is welcome.  As it happens, I was listening to Bloomberg Radio when the new high-water mark was first achieved.  A Surveillance commentator played down the fact that the S&P 500 had not yet recovered all its recession losses (although it’s close), saying that the use of the S&P over the Dow is “just” a question of “institutional bias.”

That’s simply incorrect.  …hence this post.

what’s wrong with the Dow

There are three reasons professional investors use the S&P 500 to benchmark their performance rather than the Dow:

1.  wider coverage.  The Dow Industrials consist of 30 American companies; the S&P, as the name suggests, has 500.

2.  greater relevance.  The Dow consists, by and large, of very mature, slow-growing firms.  No Google, no Apple, no Qualcomm, no Amazon.  No biotech.  Home Depot and Wal-Mart are the only retail stocks.

3.  Dow construction is weird.  For reasons best known to himself, Charles Dow decided not to make a stock’s total market value be the measure of its weighting in the index.  He chose the per share stock price instead.  It was probably easier to calculate.

This decision has dire effects on the index.  A 1% change in the price of IBM, whose shares sell for $206 each, counts for over 7x as much in the index as a 1% change in the price of Microsoft, even though the two companies have almost the same total market value.  Why?  It’s solely because MSFT has split its stock in the past to maintain an “affordable” share price, and sells for $28.35 a share.

That’s right.  In the Dow, even a tiny company with a high per-share stock price would outweigh a behemoth with a gazillion shares at a low per-share price.

At least Charles didn’t pick the number of letters in the company name as the weighting factor.

how to game the Dow

What would I do if a pension fund hired me as an equity manager and gave me the Dow as a benchmark?  First of all, I’d have to consider whether I’d want to work for a bunch of nut jobs.  But the strategy for beating the index is clear.  I’d try to figure out whether we’re in an up market or a down market (harder than it sounds).  If the former, I’d buy the ten companies with the highest per share stock prices.  If the latter, I’d pick the ten with the lowest prices.  Unless you were unlucky enough to have epic  clunkers like Bank of America or Hewlett-Packard (both Dow components), nothing else would matter.

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