Socially Distance Yourself from the Fed and Mainstream Stock-market Analysts

The coronavirus-induced trend of social distancing has pervaded every aspect of the culture now. From personal relationships to team sports, no one wants to get near anybody anymore. If there’s anyone you really ought to consider avoiding, though, it’s corporate-media financial analysts.

These people are not your allies in any sense of the word. They depend on you because without an audience, financial commentators couldn’t exist. Their role is to assign annual price targets and ratings like “overweight,” “neutral,” and “underweight” to all of the most heavily traded and talked-about stocks.

They also make revenue predictions prior to quarterly corporate earnings reports. The data strongly suggests, however, that analysts consistently underestimate how much money these companies made. That sets the companies for an easy earnings “beat” since the bar has been set so low.

For a long time, the earnings “beat” rate for S&P 500 companies has been around 67%. It really ought to be closer to 50%. Yet, the analysts seem to be intent on under-promising so that the companies can look like they’re over-delivering. It’s a bias that skews the results as the so-called earnings “beats” tend to send the share prices higher.

Why would analysts want to make it so easy for companies to outdo their projections? It’s entirely self-serving as the analysts want to ensure that their own predictive “win” rate is high. As long as they keep setting a low bar, they can assign positive “overweight” ratings and high 12-month price targets and they’ll be right most of the time.

Courtesy: Yahoo Finance

Their reputations depend on their track records, so this system of self-fulfilling prophecies keeps these analysts on the right side of the trade. It doesn’t really benefit you and me, though, since the corporate analysts are also wrong much of the time – and of course, they won’t remunerate your losses if you lose money based on your recommendations.

In terms of profit performance, don’t count on these analysts to do much better than random stock picking. This was demonstrated in hilarious fashion in a recent experiment conducted in Norway. In the experiment, professional market analysts were pitted in a competition against “an astrologist, a pair of beauty bloggers, and a group of five cows.”

Naturally, the cows picked stocks at random. All participants held their chosen stocks for three months. The outcome was humorous but telling: “The beauty bloggers performed best with a 10 percent return, while the stockbrokers and the cows got basically the same results, with a 7.26 percent return and a 7.28 return respectively. The astrologer [recorded] a sub-five percent return.”

Similar experiments have been recorded in the past, with similar outcomes. For example, in 2010 a Russian chimpanzee “outperformed 94 percent of the stock analysts in the country over a three year period.” Eight years later, a cat in the U.K. picked winning stocks better than “both a team of students and stock brokers.”

Courtesy: smartasset.com

If you think that’s laughable, get a load of this: very soon you can expect the Federal Reserve to venture into stock picking. In fact, Boston Fed President Eric Rosengren recently revealed let the cat out of the bag, saying, “We should allow the central bank to purchase a broader range of securities or assets.”

When interpreting Fed-speak, we have to be able to read between the lines. The Federal Reserve has already starting buying up corporate bonds and mortgage-backed securities, and of course they’ve been buying government bonds for years. Stocks are undoubtedly on their radar – after all, the Fed has been relentlessly propping up stock prices for over a decade now.

Quincy Krosby, chief market strategist at Prudential Financial, summed up the situation as the Fed’s stock-buying binge is likely close at hand: “Nothing is out of the question… Everything is on the table now that was not even a potential six weeks ago.”

The words “conflict of interest” come immediately to mind as one considers the bizarre prospect of the Federal Reserve picking stocks. Personally, I imagine that the Fed will at least do better than mainstream market analysts. Whether they’ll outperform the cat is a separate matter entirely.