We often talk about consensus – for example, in the market or among analysts – but an interesting thing about an organisation the size of US financial giant Citigroup is it employs so many staff it effectively has its own in-house consensus. That may not be so helpful when it comes, say, to building any sort of financial model but, as an insight into the psyche of the market, it can be quite instructive.
Towards the end of last month, Citigroup’s research arm published a note that began by observing: “The average consensus rating on all European stocks is at a 25-year low.” Given all that is happening in Europe, that is interesting in itself but, far more so, is the following chart, which shows the net of all the ‘buy’ and ‘sell’ recommendations Citigroup analysts have made about stocks over the last 20 years.
The first thing to note here is the inclination of the analysts towards overconfidence on the upside. The most positive possible score may be 5 but, with the most negative possible score 1 rather than 0, an average score would be 3. The fact therefore that the overall score averages closer to 2.5 reveals the natural bias of the analysts towards more positive recommendations over negative ones.
Still, despite the impression we may sometimes give on The Value Perspective, deep down we know that analysts are humans too and, as such, they merely reflect what is going on in the market. Indeed, their recommendations here correlate very closely with equity markets over the last 25 years – when everything is awful, they are very bearish and when everything is great they are super-bullish.
Very closely, that is, except for the last couple of years as consensus and prices have diverged for the first time in two decades – so much so, in fact, that according to Citigroup, “the gap between analysts’ ratings and price levels in the equity market has never been wider”. Just what is going on here and what conclusions might we draw?
Here on The Value Perspective, we are stockpickers, not economists, so we will stand back and defer to Citigroup’s explanation for the gap, which is: “This ‘contrarian’ stance from analysts suggests either they have broad fundamental concerns – for example, valuation and/or growth – or they are struggling with a combination of excess liquidity, historically low interest rates and fast-moving markets.”
Looking at it all from the bottom up, we would certainly agree there are a fair number of reasons to be concerned about companies – not least the prospects for earnings and earnings growth. In one respect, however, the reasons for the two lines in the above chart diverging are not as important as the strong likelihood that sooner or later, mean reversion being what it is, they will come together once more.
And, in an echo of Mind the gap, where we speculated on what factors might trigger a huge rise or fall in equity markets over the coming year, possible reasons for such a convergence could leave you feeling bullish or bearish. Bullish because the analysts could turn more positive, which tends to push up prices; bearish because the markets could fall into line with the analysts and prices collapse. Depending on your inclination, you could go either way – or you could do like us and simply admire the chart.