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Does Analyst Accuracy Correspond With Seasonality?

Justin Rohrlich July 21, 2010 3:35 PM|

       An academic paper says seasonal affective disorder increases pessimism during winter months, yet it offsets an overall tendency toward overenthusiasm.

A study published in the Journal of Behavioral Finance called “Analysts Get SAD Too: The Effect of Seasonal Affective Disorder on Stock Analysts' Earnings Estimates,” by Steven Dolvin of Butler University
, Mark Pyles of the College of Charleston, and Qun Wu of SUNY Oneonta, examines “the potential effect of seasonal affective disorder (SAD), a documented psychological condition that produces heightened pessimism and risk aversion during the fall and winter months, on stock analysts' earnings estimates.”

Dolvin, et al, write:

Our results suggest that analysts are generally optimistic in their forecasts but significantly less so during SAD months. Given that estimates generally exhibit an optimistic bias, our findings suggest that seasonal depression and its associated pessimism actually offset an existing positive bias and makes analyst estimates, as a whole, more accurate. It is well-known that reducing bias generally improves accuracy, so it is somewhat ironic that the bias associated with SAD actually makes estimates more, rather than less, accurate. This, however, results from the pessimistic bias associated with SAD offsetting an existing positive bent in overall earnings forecasts. Thus, there is a net reduction in overall estimate bias, which, as would be expected, improves forecast accuracy.

Before dismissing these findings as yet another silly exercise among academics running out of things to study, consider this: Yale professor Robert Shiller “can’t imagine making investments without incorporating the wisdom of behavioral finance.”

“We’re talking about playing a game against other people,” he told Institutional Investor. “How do you ever play a game without thinking about their psychology?”

Jerry Taylor, a senior fellow at the Cato Institute and one of the leading minds in US economic policy, tells Minyanville that “there’s a big field of behavioral economics that tries to isolate these types of anomalies.”

“There are dozens of funds that try to take advantage of these sorts of insights to build their investment strategies for their clients,” he says. “They may be correct, I don’t know. But there is an appetite for this sort of information. If the information people are chewing over is affected by these factors, then you have an advantage because you are trading on better information than other market actors.”

Independent trader Sean Udall says simply, “The market IS behavior.”

Meir Statman of the University of Santa Clara concurs.

“There are enough papers now that show risk is not what underlies outperformance. It is emotion; it is sentiment.”

Anthony Randazzo, director of economic research for the Reason Foundation says, “I do think that seasonal factors can actually impact a number of things, the way we look at the markets. There really is no doubting the notion that the field of economics can suffer from fits of irrational exuberance,” which we’ve all seen, in addition to fits of irrational bearishness.

And Jeff Macke of Macke Asset agrees--with a minor caveat:

It's hard to link SAD directly to pessimism but it's certainly not a reach to suggest seasonal impact on performance of both analysts and corporations. It’s funny -- I was just telling Pete [Najarian] that Nokia (NOK) sucks so much because of its latitude. But I think it's a much more nuanced problem than "SAD makes people pessimistic.” Correlation isn't the same as causation. From where I'm sitting the study is simply a reminder that performance in any endeavor is impacted by workers' physical and emotional condition.

Institutional Investor further details the increasing adoption of behavioral economics by fund managers:

Over the past 15 years, there has been a steady increase in the number of fund managers that are using behavioral finance concepts to select stocks and construct portfolios. One estimate is that half of the 200 listed small-cap value funds use some form of behavioral finance in selecting their portfolios. Such firms as Fuller & Thaler, Chicago-based LSV Asset Management and even fund behemoth J.P. Morgan Asset Management (JPM) have deployed strategies that use behavioral concepts to select equities for their portfolios. And all of them are beating their market benchmarks over the long term.

So far, the behavioral finance strategy appears to be paying off. Since inception in 2003, the JPMorgan Intrepid Value Fund has delivered annualized returns of 8.09 percent, compared with 6.74 percent for the Russell 1000 value index. JPMorgan Intrepid Growth has returned 6.79 percent a year since its 2003 inception, beating the Russell 1000 growth index return of 6.20 percent.

In addition, a growing number of investment companies, ranging from Des Moines, Iowa-based Principal Global Investors, a division of Principal Financial Group (PFG) to Catalpa Capital Advisors, a New York hedge fund firm headed by Joseph McAlinden, a former chief investment officer for Morgan Stanley (MS), are using behavioral finance tools to help shape their portfolios, even if they are not the mainstay of their investment strategy.

The authors of the SAD study do concede that:

...there are multiple potential explanations for analyst bias. Some fall into the category of incentive based issues. Other explanations revolve around the relationship between analysts and the firms they cover. For example, Degeorge, Patel, and Zechauser [1999] suggest pessimistic bias results from firm managers' desire to beat forecasts. Consistent with this notion, Matsumoto [2002] argues that firm managers guide analysts toward pessimistic targets to then beat the target. Chan, Karceski, and Lakonishok [2003] suggest analysts tend to become pessimistic over time in order for firms to have positive earnings surprises.

As far as incentive-based issues go, Lynne Collier, an analyst with Sterne Agee tells Minyanville:

Subconsciously, analysts may be more pessimistic or optimistic going into bonus season, when analysts can become more irritable and stressed. Think about the general workforce, where a bonus could make up, say, 5% of a person’s overall compensation. For an analyst, it could be 50%, 70%. Bonuses at that level create a lot of concern and anxiety which may foster pessimism.

Greg Schroeder, managing director, and senior analyst at Wisco Research says:

Maybe there is some subconscious behavior that results in a pessimistic forecast. I don’t think seasonal changes affect how I forecast or how I model companies, though. When analysts come back after Labor Day, that’s when we’re trying to close out the year and earn our bonuses. When you’re competing for a bonus, there’s a really hard run from September through January, which might result in a little more pessimism.

Money manager Shawn Hackett, founder and president of Hackett Financial Advisors has a unique take on the SAD study.

He says:

We all know that when you have less sunlight you are more depressed. If you’re more depressed during those times, you’re generally less optimistic. Having said that, the market performs best from late fall to spring, while the period from late spring to late fall is the worst period for the market. Historically, over the last 100 years, the best time to hold stocks has been between the end of October into the end of March. If everyone is supposedly bearish because of the weather, it’s a great contrarian indicator, which is interesting because, going by the results of this study you would expect the market to play out in exactly the opposite way.

Of course, there are always those, like Warren Buffett, who likes Coca-Cola (KO) stock because he enjoys Coca-Cola.

No matter what time of year it is.

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