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Traders work on the floor of the New York Stock Exchange June 18, 2012. (BRENDAN MCDERMID/REUTERS)
Traders work on the floor of the New York Stock Exchange June 18, 2012. (BRENDAN MCDERMID/REUTERS)

Earnings down? Analysts say “buy”! Add to ...

As earnings expectations decline, you might think that analyst recommendations would fall too. But you would be wrong.

The second quarter earnings season is about to begin, with Alcoa Inc. reporting its results after markets close on Monday.

Bloomberg News noted that analysts following companies within the S&P 500 believe earnings will fall 1.8 per cent over last year.

If correct, that would mark the first earnings retreat since 2009.

Yet, as Barron’s noted, there is an apparent contradiction between earnings expectations and analyst recommendations. The same Bloomberg piece that mentioned the expected earnings retreat also pointed out that one measure of bullishness among analysts is at its highest since Bloomberg began tracking it in 2000.

That is, 247 companies within the S&P 500 have more “buy” recommendations from analysts than “sell” recommendations or “holds.”

From Bloomberg: “Bullish recommendations have been expanding even as Wall Street firms cut their forecast for second-quarter net income in the U.S. to a decrease of 1.8 per cent from a gain of 2 percent in April, more than 10,000 estimates compiled by Bloomberg show.”

How can earnings expectations go down and analyst recommendations go up? The top explanation is that, heck, this is just one earnings season, reflecting corporate activity over the course of one quarter.

Analysts tend to look ahead – with target prices alone usually forecasting expected share price gains over the next 12 months – and they believe that earnings growth will resume its upward trend in the second half of the year.

But what’s interesting is the trend: Bullishness is increasing even as the economic and earnings backdrop appears to be deteriorating.

As Bloomberg reported, analysts have a total 5,898 “buy” recommendations on stocks within the S&P 500. That’s 9.4-times the number of “sell” recommendations, up from 8.4-times last year.

Yet, it isn’t clear why analysts are more enthusiastic about stocks now than they were last year, other than the vague observation that the S&P 500 is below its average valuation since the 1950s.

In its article, Bloomberg helpfully noted that the last time earnings expectations and analyst recommendations diverged was the third quarter of 2009.

That worked out okay: The S&P 500 was six months into a rally that has continued, with the occasional interruption, ever since.

But that doesn’t mean this is a signal that should be ignored. Analysts, like economists and strategists, have a dismal track record for calling turns in the market – meaning that all those “buy” recommendations might amount to nothing more than a whole lot of hope.

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  • Alcoa Corp
  • S&P 500 INDEX
  • Updated August 18 4:01 PM EDT. Delayed by at least 15 minutes.

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