The darker side of the estimates
But what if there was another, much darker, force at play when analysts and economists produce estimates and forecasts? Perhaps a conflict of interest. A conflict of interest that sees these individuals, in the employ of big sell-side banks not only set estimates (and the mood of the market), but trade in it also. In other words, they have skin in the game.
As noted earlier, the market lives and dies by estimates, be they unemployment or earnings or otherwise, and how well the actual data does versus them. If the actual data surprises to the upside of the estimate, then the market rises. If the actual is lower than predicted, then a move down is usually what follows. There appears to be no greater influence on market movement than the phenomenon of ‘estimate surprises’ but they are also one of the easiest mechanisms to manipulate.
This has been a topic of great debate and study for many years amongst academics and practitioners alike. Of all investigations, Professor Andrew Calls proves to be the most extensive and meticulous in its findings. He and his colleagues set out to examine as many earnings estimates as they could find on US listed stocks. They studied 370,000 individual analyst forecasts, spanning 10 years, and found a pattern emerge amongst bearish analysts who wanted the price to fall on a particular company.
They found 30,000 instances (almost 10% of the total data set but 25% of all bearish analyst estimates) where a bearish analyst set astronomically high earnings estimates, thus driving the average estimate, or consensus, higher and making it harder for the business to beat it. When the business didn’t beat the estimate, the stock price fell, and the analyst got what they wanted. This was found to be more prominent when an analyst was under pressure to justify their bearish stance when the rest of the market was bullish. To be bearish on a stock is to expect a price decline as a result of poor financial performance, so to set such high earnings estimates is a contradiction to your own opinion and clearly manipulation in play.
Professor Call and his team stressed the risks present in such a conflict as the one we see above, this level of influence on both sides of the trade essentially allowing these individuals to ‘rig the game’.
This is not to say that recent unemployment estimates, and just how wrong they were and the influence they seemingly have had on market valuations, are suspicious. Although they could be. Market sellers, which these banks are, need buyers and buyers generally buy more freely when feeling positive and optimistic of the future.
My only recommendation would be to take such predictions with a pinch of salt in the knowledge that there are many reasons why they could be wrong and not many examples of where they are right.
About George Cliff MBA
George is both a passionate research analyst and Pre-Sales Technical Manager at Clever. An MBA graduate and Investment Management Certificate candidate, George spends much of his time immersed in the industry, in search of new opportunities and practices to better both the business and its offerings. Integral to the continued development of the firm, George is responsible for many of the projects and reports that have shaped the last five years of operations at Clever. He is also very active in the sales function as a key presenter and content writer, providing technical assistance and guidance through the pre-sales process.
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