Friday, April 15, 2011

Uh, Oh: Analysts are More Bullish than Company Managements

What does it tell you when Wall Street analysts are moving their earnings forecasts higher - but management is moving its guidance lower?

It tells you that this market might be more risky than is generally perceived, according to Savita Subramanian speaking yesterday at Merrill Lynch.

Savita is a quantitative analyst; she uses the huge database of economic and market data at Merrill to derive her portfolio recommendations.

The trick in quantitative work, of course, is that past data is not always the best guide for the future. Moreover, as Savita noted yesterday, market leadership can change fairly quickly, and what is working during one period of time may not work in the next period.

Still, this wide divergence between the analyst community and management pronouncements troubles Savita. If nothing else, she said, analysts usually follow management lead in developing their forecasts, so we are in a fairly unusual period.

According to Savita, the widest disparity between the analysts and management can be found in the energy sector. While virtually no company managements have raised earnings guidance, Wall Street has been aggressively raising their earnings forecasts by a ratio of 3:1 (that is, there have been three times as many upward revisions to EPS forecasts by the Street to downgrades).

Other sectors where Wall Street is more bullish than the companies include technology and materials.

In Savita's work, companies that beat Wall Street forecasts are more likely to outperform the market in the next 3 to 6 month period. On the other hand - and here's the part we should worry about - companies that fail to beat Street forecasts are more likely to underperform.

As we are just beginning the release of first quarter earnings, this might be something to monitor.