The SPX Breaks -- And Retakes -- Its 200-Day Moving Average!
by Ian Harvey
June 18, 2012
Analysts on Wall Street provide a lot of great information for those looking for fundamental data on a specific company. They are also a valuable source for stock traders, acting as a great contrarian signal – even though this may not be always be preferable for all types of traders. When everyone expects a stock to move higher, all good news is priced in, and buying power gets exhausted, leaving the stock with nowhere to go but down.
An “analyst” is a financial professional who has expertise in evaluating investments and puts together "buy", "sell" and "hold" recommendations for securities.
They are also known as a "financial analyst" or a "security analyst".
Analysts are typically employed by brokerage firms, investment advisors, or mutual funds. Analysts do the grunt work for brokers, preparing the research that brokers use. The most prestigious certification an analyst can receive is the Chartered Financial Analyst (CFA) designation. Analysts usually specialize in specific industries or sectors to allow for comprehensive research.
The opposite tends to happen for stocks that everyone hates – which also includes analysts. If the analyst community is universally bullish on a company, that may be a warning for that stock. If they are all advocating to "Sell," then the selling could be close to over. As we prepare for the second half of 2012, it is worthwhile to go back and see how stocks did in the second part of the year, depending on analysts' "Buy" recommendations.
The study of analyst performance involves using buy/hold/sell data from Zacks Investment Research, and looking at stock returns in the second half of each year since 2000 (Note: Consideration was taken for stocks with a minimum of 10 analyst recommendations and 5,000 contracts in open interest only). For every year the stocks are placed into three groups depending on the percentage of buy recommendations. The table below illustrates that stocks with the most bearish analysts' sentiment (the fewest percentage of buy recommendations) had easily the best returns. Those stocks averaged a 5.70% return for the second half of the year. Other stocks averaged between 2.62% and 2.70%.
The next table shows data since 2008. The results are similar and the conclusions are the same. Do not count on analysts to predict the direction of stock prices.
Analysts by Year
The table below shows how the analysts did in each individual year since 2000 -- an improvement can be noted! In 2011, there was pretty much no difference between the stocks on which analysts were most bearish and on those toward which they were most bullish. In 2010, stocks seeing the most bullish opinion among analysts outperformed the other groups. So going against the analysts is not a slam dunk, but over the longer term, it has paid to be a contrarian.
The sentiment toward a certain stock is most significant when it is running counter to price action. When a stock is moving higher in the face of negative sentiment, it means there are a lot of people unconvinced of the rally. That's a sign there is a lot of sideline money that can pour into that stock when the negative sentiment capitulates and turns bullish. This is a recipe for a fast-and-furious rise and/or a long, sustained rally.
If you're looking for stocks to trade in the second half of this year, the list below may be a good place to start your research. These are stocks that would fall into the "bearish" analyst bucket in the tables above, are positive on the year, and have been trading above their 200-day moving average for the most consecutive days. This would appear to fit the bill for negative sentiment in the face of positive price action.