In the Forest

March 2011

Many investors cherish the notion that if only they had instant access to the information of market professionals (stock research, broker calls or economic forecasts) their wealth-building dreams would be much further advanced. So, what if you had acted on those big professional calls in the past year?

Financial information group Bloomberg recently carried out an analysis of broker recommendations for stocks in the US equity benchmark, the S&P 500 index. It found the companies that analysts recommended most highly rose by 73% on average in the period from the trough of the market in March 2009 until early 2011. That sounds pretty good until you realise that the index itself rose by 88% in the same period!

In comparison, the stocks with the fewest “buy” recommendations in the Bloomberg survey rose by a staggering 165% on average during that period, or more than twice as much as the "top" stocks.

In New Zealand, one of the “top” stocks that brokers favoured at the beginning of 2010 was Tower.  Investors would have been somewhat disappointed in the performance of Tower as the actual return for the year was 0.96%.  In comparison, the return for the NZ Sharemarket (NZX50) was 2.44%.

Why analysts get it so wrong can be easily explained. Everyone has a theory about what will move the market in the coming year, but this always depends on a couple of variables:

• You have to know what's going to happen
• You have to know how the market will react
• And even if you have a perfect crystal ball, there’s no guarantee the market will respond the way you think it will.

Regardless of the level of analysis that may be done, things often don’t work out like you think they will.

For instance, analysts in the Bloomberg survey made a big call in favour of healthcare stocks based on the expectation that Obama administration's healthcare reforms would not pass into legislation. As it turned out, the legislation did pass and healthcare was the worst performing of the 10 economic sectors in the S&P 500 last year.

Whilst the “experts” may be lucky some of the time with their “top picks”, history has shown that trying to time your way into and out of markets or speculating in order to achieve results just doesn’t work, as invariably there will be unpredictable events that occur. 

If the professionals who are paid to analyse companies can get it wrong, what does that say about the chances of anyone being able to outperform the market based on individual stock research?

It would seem the closer you get to the trees, the less you can see the forest.