the FINRA Guide to Understanding Analysts’ Recommendations

Yesterday someone sent me a link to Understanding Securities Analyst Recommendations, written by the Financial Industry Regulatory Authority (FINRA), the brokerage industry trade organization.

The short article is surprisingly candid and contains important information, although couched in very abstract language.

The highlights (paraphrased by me):

–brokerage house analysts, and the brokerage houses themselves, are subject to enormous potential conflicts of interest when it come s to saying what they think the future performance of a given stock may be.  For instance, –a company may select a brokerage house for lucrative investment banking business based on how favorably the firm rates its stock

–conversely, it may refuse to give corporate information to analysts who rate the stock unfavorably.  The company may “forget” to return phone calls, avoid appearing at conferences sponsored by the analyst, refuse to appear with the analyst at public or private investor meetings, or not acknowledge requests for information from institutional investors that are directed through the offending analyst.  The company may even more overtly try to get the analyst fired.

–very large money management companies may build up gigantic positions in the stock of a given company.  Powerful portfolio managers may have large stakes riding on the stock’s performance–and the positions may well be too big to sell quickly, in any event.  So they may pressure brokers and their analysts to maintain a favorable opinion on the stock.  Their threat–to withhold trading commissions from a firm that downgrades the stock.  Same thing about firing the analyst, too.

–as a result, the terms brokers use to rate stocks may not be self-evident.  “Buy,” for example. may not be a particularly good rating.  “Strong Buy” or “Conviction Buy” may be what we’d ordinarily understand as”buy.”  “Buy” may be closer to “Eh” or “Hold.”  Of course, analysts may also have one official opinion in writing and another that it expresses verbally to clients.

Two other worthwhile points the article makes:

–some analysts may not be highly skilled, so their recommendation may not be worth much.  Rookies may not have enough experience, for instance, and they may be more susceptible to outside pressure than others.  Analysts may not know a spreadsheet from a hole in the ground but have the ear of management.  (Oddly, old-fashioned managements continue to give information to favored analysts that they deny to shareholders.)

–the fact that a portfolio manager owns a stocks, even if it’s a large position and if his analyst appears on TV saying positive things about it, the manager may hold the stock for completely different reasons (more on this tomorrow). Anyway, the FINRA page is well worth reading.

Wall Street strategists vs. analysts: who to believe…


…what to do with your equity portfolio now.

The S&P 500 made an another all-time high yesterday.  Now at 1650, the index has already made greater gains than any professional I’m aware of had predicted for the entire year.

Analysts say the market will be higher in 12 months.  Strategists say the opposite.

What to do?

earnings aren’t the issue 

Stocks are reasonably valued at 15x 2013 earnings and less than 14x next year’s.  They’re not as cheap as they were at the bottom in 2009, but they’re not wildly expensive either.

The traditional comparison with the other big class of liquid investments–government bonds–is to measure the 30-year Treasury bond yield against the earnings yield (that is, 1÷PE) on stocks.  On this measure, stocks are already trading as if the long bond were at 6.5%.  This suggests that most, if not all, of the eventual rise in bond yields that will occur when the Fed returns interest rates to normal, is already factored into today’s stock prices.

earnings growth isn’t the issue

Both analysts and strategists think that corporate profit growth will accelerate from here and reach about a 10% year-on-year rate of advance in 2014.  (By the way, the 10% figure is not itself a very controversial one.  It describes an average year.  It’s also the figure I’d start with as the most likely outcome, and move up or down depending on whether I felt strongly positive or negative.)

the issues?

Stock investors seem to me to be vaguely uneasy that the market has gone too far too fast.

It’s a little scary that retail investors who sold in 2008-09 are only now–after a four-year, 140% rise in the S&P 500–putting their money back into stocks.  Arguably, when blunted pencils start moving into the box, it’s time to move on.

Saying the same thing in a different way, the current rally isn’t based on the fact that corporations are reporting surprisingly good earnings.  Rather, the market’s price-earnings multiple (the price people are willing to pay for a unit of earnings) is rising.

More relevant, in my view, is the worry that as the Fed raises interest rates from today’s ultra-low levels the resulting fall in bond prices will have a negative effect on stocks.


We can interpret the PE expansion the market is undergoing as simply a return to more normal levels after years of recession-induced fear.

The eventual rise in interest rates will be preceded by strong corporate earnings growth, which will mitigate the negative effects of higher rates.  That’s perhaps the biggest lesson world central bankers have taken from the quarter-century of economic misery in Japan, where the government nipped economic recovery in the bud twice, by tightening prematurely.

In similar instances of Fed rate-raising in the past, stocks have gone sideways to up.

We’re very close to the time of year when in normal times Wall Street begins to look at, and discount in current prices, earnings prospects for the following year.

The technical tone of the market remains bullish.

what I’m doing

My inclination is not to make major portfolio changes but to do routine maintenance instead.

Specifically, I’m:

–going through my holdings, position by position, and asking if the reasons I established it are still valid, and

–checking position sizes, to make sure none are so large they pose a risk, or too small to do any good.

finding clunkers

Everyone has blind spots.  And everyone has clunkers that his eyes somehow skip over when doing a portfolio check.  One way I’ve found to help myself to see these “invisible” losers is to imagine that I’ve got to raise, say, 10% cash immediately.  What would I sell to do so?  Unfortunately, but not unexpectedly, one or two problem cases pop up.

Any money I “find” this way I’m probably going to take my time putting back into the market.  That’s as much defense as I usually do.  And it’s all I’m going to do now.

corrections are a fact of life

At some point, the S&P is going to fall by 5% – 10%.  That’s just the way stocks work.  This is a worry for day trades.  But for investors–especially one who are doing routine portfolio maintenance and culling losers–this shouldn’t be a concern.






Wall Street strategists vs. analysts: S&P index and earnings forecasts

a little history

Pre-Great Recession, the peak for annual S&P 500 index earnings came in 2006, at $89.49.

The subsequent low, in 2009, was $60.78.

The index established a new earnings high in 2011, at $96.58.

2012 produced a 6.6% advance over 2011, at $103.04.

2013-14 earnings projections (all from Factset )


Wall Street strategists, who had originally been predicting virtually no earnings growth for the S&P in 2013, have grudgingly upped their estimate to $109.15, a year-on-year gain of 6%.  They’re penciling in a more substantial yoy advance of 9.2% for 2014, to $119.20.

Despite this positive news, they expect the S&P to decline from the current level over the coming year.


As I mentioned yesterday, both analysts and strategists have underestimated the earning power of S&P companies.  Analysts, who are usually the wide-eyed (over-)optimists, have been much closer to reality, but even they have fallen short in their prediction of S&P profit growth by a percent or so.

Analysts think the S&P will earn $110.36 in 2013 and 122.86 in 2014.  Those are gains of 7.1% and 11.3%.

As Factset interprets their calculations, analysts expect earnings reports to cause the S&P to rise as the market discounts them–by about 5% from here.

earnings growth by sector

According to Factset, analysts see sectoral earnings gains for the S&P for 2014 over 2013 as follows:

Telecom          +20.1%

Materials          +18.4%

Consumer discretionary          +16.5%

Industrials          +11.5%

S&P 500          +11.2%

IT          +11.0%

Financials          +10.1%

Staples          +10.0%

Energy          +9.7%

Healthcare          +8.9%

Utilities          +4.5%.

what strategists and analysts have in common

Both think that slow global economic recovery will continue.

Strategists expect very tepid upward movement in corporate until close to yearend, after which they expect the pace of growth to pick up.  Analysts are anticipating better near-term performance, but also with acceleration as the new year begins.

where they differ

1.  Analysts think earnings growth will be considerably better than strategists do.  If you look at the breakout of expected earnings performance by sector, you’ll notice that analysts are expecting economically sensitive areas to have the most robust earnings advances (note, in particular, Materials).  Energy prices will apparently be staying low–another plus for most world economies.   Defensive sectors will lag.

One caution:  analysts are always optimistic. Also, it raises eyebrows a bit if the bulk of the growth is several quarters in the future, where strong evidence is harder to find.  On the other hand, analysts have been right so far in being optimistic.  And it’s the strategists who are back-loading their growth forecasts.

2.  The more significant difference is that analysts think the market is going up; strategists think it’s going down.

Factset doesn’t give an explanation for this;  it just reports the numbers.

I don’t think this difference has much to do with earnings growth, though.  Strategists think the market’s price-earnings multiple is going to contract over the coming 12 months, even though they think earnings growth will accelerate.

Why would this be?  My guess is that strategists are thinking the Fed will begin to raise interest rates late this year or early next, and that this will cause the price investors are willing to pay for S&P earnings to shrink.

Tomorrow:  my take on all this.

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

 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 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 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.