Analyst Sentiment Finally Net Bullish: Time to Bail?

For the first time since April of 2007, the number of profit forecasts that have been raised in June was greater than the number that were lowered, according to data collected by JPMorgan Chase (NYSE:JPM). There were 896 raised forecasts in comparison to 886 lowered, not a wide margin but net bullish nonetheless. This comes on the heels of first quarter earnings, where analysts were shown to be overly bearish. For the second quarter, the scenario has thus far played out the same way, with some 75% of firms beating the Street’s estimates in second quarter reporting. Wall Street estimates had fallen extremely hard during the second half of 2008, at the fastest pace on record, and analysts are just now starting to bring them back up.

In general, we view analysts estimates as a benchmark and don’t believe that they should receive too much importance. However, market observers have seen the lift that one analyst’s changing opinion can have on a stock. For example, look at what happened when Meredith Whitney correctly predicted the earnings blow out by Goldman Sachs (NYSE:GS) a day prior to their reporting. The company did not report a single number on that day, but the fact that a superstar analyst was bullish on the company lifted the stock nearly 6%. As this example illustrates analysts can and do move the market, and the fact that analysts as a group are becoming more bullish could have a substantial effect on the broad market. According to Bloomberg, consensus Wall Street estimates for full year 2009 profits of S&P 500 firms has increased to $74.55 from $72.54 in May. The consensus view of analysts puts the forward looking expected price to earnings multiple at about 13.13x. This not a rich multiple when compared to the 50-year historical average of 16.54x. If analysts continue to boost estimates for the full year the this valuation metric will likely continue to look attractive.

Wall Street was left looking much too bullish coming into the recession and were forced to rethink their estimates in light of a credit market that had seized up and very difficult environment to forecast. They dropped profit expectations at the fastest pace ever, with profit estimates lowered on four out five revisions in October 2008. The results have shown that analysts quarterly figures have been too low for the past two quarters, which adds pressure for analysts to lift those estimates as even more encouraging macroeconomic data becomes available (such as today’s new home sales data). As analysts are getting demonstrably more bullish, are they getting ahead of themselves? With S&P 500 earnings currently pegged to hit $74.55 for the year, analysts are already predicting a 25% rise from last years’ predicted 2009 earnings figure of $59.80. That represents the largest increase in earnings projections in 14 years, and more upward revisions are likely on the way.

Looking at consensus analysts estimates and their trends is an inexact science because they are often proven to be on the wrong side. Recently, we have seen analysts too bullish leading into the downturn, and too bearish as the market has recovered some of its losses. Some analysts are surely better than others, but overall recently individuals would have done better investing counter to the trends in analyst sentiment. So far in the second quarter, companies have been coming up a little light on revenue, and yet beating earnings. Which means analysts have underestimated the amount of cost cutting going on in corporate America. This is a completely rational thing for companies to do right now, but it does not suggest an overly bullish stance on the market from our view. If analysts continue to raises estimates to avoid being characterized as overly bearish again, then we would not be the least bit surprised to see them come up on the wrong side of the trend again in the second half.

Analyst Sentiment Finally Net Bullish: Time to Bail?

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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