Sell-Side Analysis Most Useful When Most Wrong

New York Stock Exchange
A trader works on the floor of the New York Stock Exchange (NYSE) in New York. Photographer: Scott Eells/Bloomberg

Equity analysts work harder when economies and financial markets are slumping. They also have more influence over stocks -- even though their earnings forecasts are less accurate.

Economists Roger K. Loh and Rene M. Stulz, studying analyst reports from 1983 to 2011, concluded that greater uncertainty and career concerns amid recessions and market crises mean projections are tougher to make and prove less accurate. Even so, harder times push investors to rely on them more for guidance and so increase the usefulness of analysis.

The paper, published by the National Bureau of Economic Research in Cambridge, Massachusetts, focused on analysis by sell-side firms, a term referring to banks and similar institutions that sell financial products.

The economists studied what happens to a stock in the days following a change in recommendation during what they labeled bad times. That included the October 1987 stock market crash and the credit crisis of 2007 to 2009.

“While their forecasts are less accurate during bad times, analysts are more active and their forecast and recommendation revisions are more influential,” said Loh of Singapore Management University and Stulz of Ohio State University. “Consequently, our evidence shows that analysts are more valuable in bad times.”

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Central banks outside the U.S. would be among those hurt by rising bond yields, according to estimates from Carl Weinberg of High Frequency Economics.

Calculating that two-thirds of the $12 trillion in foreign exchange reserves are held in bonds with an average duration of seven years, Weinberg estimated that every percentage-point rise in yields reduces the value of bonds held by other central banks by $520 billion. A bond’s price moves inversely to yield.

For China alone, the cost of a 100-basis point rise in bond yields would equal almost 3 percent of gross domestic product, according to Weinberg.

While the Federal Reserve has accounting rules to mitigate capital losses on its portfolio, the Bank of Japan, Bank of England and most other central banks don’t, said Weinberg.

“This year may bring a catastrophic destruction of the reserve base behind the global money supply,” Valhalla, New York-based Weinberg wrote in a Jan. 6 report

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U.S. interest rates aren’t the biggest international influence over emerging market capital flows, despite the pullback last year as Fed officials began signaling a withdrawal of monetary stimulus.

A study by Kristin Forbes of Massachusetts Institute of Technology’s Sloan School of Management found that as a share of gross domestic product, U.S. interest rates had just a 12 percent correlation with private capital flows to emerging markets from 1990 to 2013.

By contrast, global growth had a 39 percent correlation while risk, as measured by the Chicago Board Options Exchange Volatility Index, had a 55 percent effect.

That provides Forbes with an explanation for why emerging markets were shaken more by last May’s “taper talk” than by last month’s actual decision to pull back asset purchases. That’s because by the end of 2013 investors were willing to accept more risk amid signs the world economy was gathering strength, she said.

Forbes presented her findings last week at the American Economic Association’s annual meeting in Philadelphia.

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The U.S. energy revolution could have a more modest impact on economic growth than early estimates indicated.

That’s the conclusion of a book released this month by the Peterson Institute for International Economics in Washington. It estimated developments such as fracking will increase economic growth by an average of 0.2 percent a year between now and 2020, or 2.1 percent in total.

That is less than some estimates, the publication said. The reason: While cheaper and more available energy will help reduce unemployment and spur manufacturing, investment and hiring in oil and gas production could come at the expense of other sectors, said authors Trevor Houser and Shashank Mohan.

Manufacturing, for example, may become more competitive, yet it accounts for less than a sixth of the country’s employment. A declining energy trade deficit could hurt factories by pushing up the dollar to the detriment of sectors such as automobiles and electronics.

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Natural disasters may not harm developed economies as much as assumed.

That’s the conclusion of a study presented last week at the AEA meeting in Philadelphia by economists Tatyana Deryugina, Laura Kawano and Steven Levitt. Levitt is the co-author of “Freakonomics: A Rogue Economist Explores the Hidden Side of Everything.”

They found that while Hurricane Katrina -- the 2005 storm that hit the U.S. Gulf Coast, especially New Orleans -- killed almost 2,000 people and destroyed more than 200,000 homes, there were only “small and transitory” effects on wages, employment and income.

Indeed, they found Katrina victims had higher incomes than people in similar cities a few years later, they experienced a short-run spike in marriage and little impact was found on either divorce or child-bearing rates.

“Hurricane Katrina massively and unexpectedly disrupted the lives of New Orleans residents,” the economists said. “It is not surprising the immediate economic experiences of the storm victims were negative. What is remarkable, however, is the rapidity with which their economic situation recovered.”

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