Interesting discussion this morning on earnings expectations and subsequent market performance. It seems that after several years of raising estimates, analysts in the current quarter have been slicing and dicing expectations for the quarter:
"When this bull market was young, back in 2003, analysts started doing something unusual. Chastened by regulators’ criticism over the excesses of the 1990s and beaten down by a recession and a bear market, they turned conservative in their profit forecasts. Their initial guesses tended to be too low, and as quarters wore on, analysts would steadily raise their projections, building investor hopes. Then companies, bouncing back from the recession, would stroll in and announce quarterly profits that blew away even the elevated forecasts.
Investors loved it, and in 2003, the Dow Jones Industrial Average rose 25%. The gains continued, at a much subdued pace, in 2004.
Wall Street is all about expectations, and as expectations rise, it gets harder for companies to keep turning in eye-popping results. Last year, the virtuous circle of analyst forecasts began to unravel. As was the case in the hype-filled 1990s, analysts found themselves more often overestimating results at the start of the quarter. Companies began to send out more warnings of problems to come, and analysts began to cut estimates, according to Thomson Financial, which tracks analyst estimates. When companies reported profits, they often beat analyst forecasts — but reduced ones."
The change has been modest, but significant. In January, analysts were looking for SPX Q1 profits to grow at 12.6%. That has since slipped to 11%. The Journal notes the reality of the aging cycle: "Bull markets usually are strongest when they are young, right after a bear market. Investor expectations are low then, and surpassing them is easier. The bull market tends to end, or at least pause, when expectations get well ahead of companies’ ability to deliver."
Note that the mere lowering by analysts may not mean much: "Thomson Financial has found analysts tend to cut forecasts by about three percentage points as a quarter wears on. Then companies have a way of beating the reduced expectations — by about three percentage points."
Bottom line: The bull market is aging, with some of the "excitement and stock surges of its youth" behind it.
Not Very Great Expectations
Amid a Return to Normalcy, Analysts Tame Profit Forecasts;
Possible Sign of Aging of the Bulls
WSJ, March 20, 2006; Page C1
The WSJ streak of taking very interesting columns and hiding them on Saturday continues.
Yesterday, they asked: Are some CEOs reaping millions by landing stock options when they are most valuable amatter of dumb luck — or something else?
"On a summer day in 2002, shares of
Affiliated Computer Services Inc. sank to their lowest level in a year.
Oddly, that was good news for Chief Executive Jeffrey Rich.
annual grant of stock options was dated that day, entitling him to buy
stock at that price for years. Had they been dated a week later, when
the stock was 27% higher, they’d have been far less rewarding. It was
the same through much of Mr. Rich’s tenure: In a striking pattern, all
six of his stock-option grants from 1995 to 2002 were dated just before
a rise in the stock price, often at the bottom of a steep drop.
lucky? A Wall Street Journal analysis suggests the odds of this
happening by chance are extraordinarily remote — around one in 300
billion. The odds of winning the multistate Powerball lottery with a $1
ticket are one in 146 million.
Suspecting such patterns aren’t
due to chance, the Securities and Exchange Commission is examining
whether some option grants carry favorable grant dates for a different
reason: They were backdated. The SEC is understood to be looking at
about a dozen companies’ option grants with this in mind.
Journal’s analysis of grant dates and stock movements suggests the
problem may be broader. It identified several companies with wildly
improbable option-grant patterns. While this doesn’t prove chicanery,
it shows something very odd: Year after year, some companies’ top
executives received options on unusually propitious dates.
analysis bolsters recent academic work suggesting that backdating was
widespread, particularly from the start of the tech-stock boom in the
1990s through the Sarbanes-Oxley corporate reform act of 2002. If so,
it was another way some executives enriched themselves during the boom
at shareholders’ expense. And because options grants are long-lived,
some executives holding backdated grants from the late 1990s could
still profit from them today."
The chart below implies that the odds against these being random are quite high. (I guess Sarbanes Oxley didn’t root out all the corporate corruption after all).
Last week it was the mortgage resets, and this week its CEO Options. Great stories, buried on the front page — of the Saturday edition . . .
The Perfect Payday
CHARLES FORELLE and JAMES BANDLER
WSJ, March 18, 2006; Page A1
How the Journal Analyzed Stock-Option Grants
WSJ, March 18, 2006; Page A5