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SmallCaps Have 99 Problems and Wrong Analysts May Be One

Being entertained by the misfortune of others is known as schadenfreude by Germans, not to mention Americans with pretentious vocabularies.

Who knows why it’s so enjoyable, it just is. So a fun exercise once in a while is to take inventory of where market analysts were most wrong. Now that earnings season is over, there’s a clear picture of which groups of number crunchers emerged with reputations so bruised they look like they’ve been riding the elevator with Beyonce’s sister.

Developing-nation analysts are front and center. With reports in from 528 of 651 companies in the MSCI Emerging Markets Index, earnings trailed analysts’ forecasts by 34 percent. Telephone companies missed by a whopping 93 percent and health-care firms by 61 percent.

Still, the index is absorbing the blows as calmly as Jay Z took the whooping from Solange. It’s up about 3 percent for the year and yesterday reached a six-month high after underperforming the S&P 500 by 35 percentage points last year. The emerging-markets gauge is looking cheap compared with the U.S., trading near the biggest discount to predicted earnings since 2006. Of course, that’s only valid if you believe those analysts who were so wrong about the first quarter.

Japan, U.S.

Japan’s Nikkei 225 (NKY) isn’t doing as well. It’s down 12 percent in 2014 after the 211 companies that reported so far trailed projections by 10 percent. Among the notable misses were Sony Corp., Sharp Corp. and Toshiba Corp.

In the U.S., you may assume that the bigger companies were closer in line with estimates because they are covered by more - - and presumably better -- analysts. If that’s the case, the schadenfreude shade should be cast in your direction because you’re wrong. Estimates at S&P 500 companies were off by 6.1 percent, while S&P 600 Smallcap Index projections were only off by 2.1 percent. The results were better-than-forecast at both because, well, America.

Of course, knowing which analysts were wrong in the past is not as valuable as knowing which will be wrong in the future. Enter Sam Stovall, chief equity strategist at S&P, who predicts that it’s small-cap analysts’ turn to be the stars of the schadenfreude.

His math -- colored by a more than 7 percent dip in the S&P 600 Smallcap since its March record -- shows that already-reduced estimates for a 31 percent gain in 2014 operating earnings per share “seem a bit lofty to us” since larger stocks in the S&P 500 are only projected to increase profit by less than 8 percent.

Of course strategists, like analysts, have been known to be wrong too. So check back at the end of the year to see if it’s Sam’s turn for some schadenfreude. But here’s one piece of strategy that can’t go wrong: If you find yourself out on the town clubbing with Jay Z this weekend, be sure to take the stairs.

To contact the reporter on this story: Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editors responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net

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