Market's collective wisdom superior to analysts'

Study says Sensex move is a harbinger of economic growth

 

They get top bracket salaries, have all the wisdom in the world about which way the economic wind is blowing, and the markets supposedly listen to them. A Morgan Stanley report released today, however, begs to differ.

 

The report said the breadth of earnings revisions by analysts followed market moves with a lag of about three months. Further, analyst stock ratings lagged the market the most, the report added.

The report — Markets lead analyst opinions, most of the time, co-authored by Ridham Desai, Sheela Rathi and Utkarsh Khandelwal — said the market led the economy by about six months. The study said the Sensex move was a harbinger of the direction of the economic growth and did it with great aplomb.
 

AHEAD OF THE CURVE
Morgan Stanley’s study of analysts’ success ratio

• The Sensex moves shows where the economic growth is headed
• Breadth of earnings revisions is reflexive of market moves with a lag of about three months
• Analyst stock ratings are the worst of the lot –they lag the market the most

“As statistical science will eloquently explain, the market’s collective wisdom appears to be superior to the collective wisdom of analysts (a subset of the market),” the analysts said.

The Sensex rose about 25 per cent in 2012 led by foreign institutional inflows of $25 billion. But analysts’ upgrade of companies and stocks was yet to kick-off in a big way.

“The market troughed in December 2008, analyst ratings did so only in July 2009. The market formed a durable base in May 2012 and no surprise, we are now seeing consensus ratings upgrades,” the Morgan Stanley analysts said.

The investment bank said the success of sell-side (broking firm) analysts follows a sine curve — if a call goes right in the current cycle, it is likely to go wrong in the next. “This is a key source of our restlessness, as we appear to have got more right than wrong in 2012,” Morgan Stanley said. “In recent investor meetings, there has been a lot of focus on our call, rather than our framework. We see this as worrying.”

So, should investors ignore analyst recommendations? Morgan Stanley said analysts’ advice can be heeded based on the extent of the macro economy’s influence on stocks. “The value of the sell-side analysts follows the correlation curve,” the investment bank said.

“When the correlation of stocks across the broad market is high, it means that the macro is influencing stocks disproportionately and it is time to listen to analysts because stocks always have idiosyncrasies. When correlations are low (like now), a macro trade is in play making idiosyncratic analysis less effective.”

Also, the framework offered by astute sell-side analysts which has greater utility than the call itself, said Morgan Stanley. “The problem for the buy-side, collectively speaking, is confirmatory bias, which is that, the sell-side becomes a source of conciliation for their own call. If the buy-side moves away from seeking comfort and focus less on the call, the value of the sell-side analyst soars,” it said.