New York – Last Sunday, the New York Times analyzed the outlook split between two groups in Wall Street: analysts who cover individual stocks and economists / strategists.
“Typically bullish in the best of times, this group [analysts] has barely budged on its expectations for earnings in the second half of 2011, even as the economists and strategists at the big brokerage firms have steadily ratcheted down their forecasts for overall economic growth,” the Times said.
Analysts’ optimism is not new. At the end of 2008, in the midst of the credit crunch, we highlighted a bleak contrast in estimates: analysts’ projected a 29% increase of S&P 500 earnings in Q4 2008, while strategists estimated a decrease of 15% in S&P 500 earnings for the same period. Back then we wrote, “bottom up analysis tends to be optimistically biased. There is nothing nefarious about this, simply the natural tendency to extrapolate. When analysts lower forecasts it is in the context of their extrapolations, resulting in incrementalism. In good markets, this tendency isn’t a big problem. Now it is.”
The split can be explained by the methodology each group applies in their analysis. Strategists use broad economic growth projections in what is called top-down forecast. Their outlooks incorporate macroeconomic factors, such as employment and manufacturing data, which are for the most part, exogenous to the analysts’ models. Analysts, on the other hand conduct bottom-up analysis mainly using data from individual companies.
If recent history is any indicator, times like these, of economic distress, top-down analysis offers a closer-to-reality view. Going back to Q4 of 2008, when analysts estimated S&P 500 earnings of 29% while strategists predicted a -15%, the actual number turned out to be -22%. Even strategists looked optimistic back then, but their predictions were closer to reality than analysts’.
Three years later, we see both strategists and analysts revising their estimates with remarkably split outcomes. As the New York Times reported, analysts are expecting a 19.5% increase, down from the 20% initially suggested, in earnings for consumer discretionary companies in Q3 of 2011. Strategists at bulge bracket firms, in contrast, warn about coming disappointments, especially in the consumer discretionary category. They have revised their initial projection of 2.5% economic growth in the fourth quarter of 2011 to a 1%, adding that the United States and Europe are “dangerous close to recession.”