Global Quantitative Research

Global Quantitative Research

9 October 2008

Global Quantitative Strategy Time to buy? The impact of the US reporting season on equity performance London

Andrew Lapthorne (44) 20 7762 5762 [email protected] Rui Antunes (44) 20 7762 5875 [email protected] Georgios Oikonomou (44) 20 7762 5261 [email protected] John Carson (44) 20 7762 4979 [email protected]

Paris

Anass Mouhsine (33) 1 42 13 66 81 [email protected]

New-York

Andy Kim (1) 212 278 5455 [email protected]

The amusement that is the US quarterly reporting season is once again upon us and it typically brings positive surprises. We find evidence of better performance during the reporting season than outside it, particularly during bear markets. So, with the VIX very high, markets sharply down since August and relative strength indicators dipping below 30, is it time to sell some Puts?

The side-show of the US reporting season is once again upon us. If history is any guide, we would once again expect a number of companies to positively surprise the market. After all, it was only as recently as the last quarterly reporting season that 70% of S&P companies beat expectations. Alas, that did not prevent earnings momentum slumping straight afterwards. Q

We find a systematic increase in the upgrade/downgrade ratio during the reporting season. We also find that there is a difference in performance, most notably when we exclude the longer year-end reporting round. Since 2000, the average annualised performance during Q1, Q2 and Q3 reporting seasons has been 2.3% versus -1.2% outside of these periods.

Q

This performance is more pronounced when we measure the returns during periods of equity market weakness; two periods specifically since the turn of the decade are 2000 to 2003 and from August 2007 to date. The results are shown in the chart below, where the difference between inside and outside the reporting season is almost 7%.

Q

The coordinated interest rate cuts yesterday were notable for their failure to inspire equity markets upwards. With such a poor economic background, investors may not want to be buying equities at the moment, but for the next few weeks at least, they may not want to be short either.

Q

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Avg weekly performance (annualised, %)

Performance of S&P during and outside of reporting seasons – 2000 to 2008 (bear market only) 2.0 1.0

During reporting season Outside reporting season

0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 -7.0 Including Q4 year end reporting

Source: SG Quantitative Research

Excluding Q4 year end reporting

Global Quantitative Strategy

The reporting season is upon us, is it time to buy? The quarterly reporting season can provide plenty of surprises, even in the middle of a profits slump!

The amusement that is the US quarterly reporting season is once again upon us. We describe the process as amusing as, no matter what the prevailing economic doom and gloom, companies always seem to deliver positive surprises. Their investor relations departments quite clearly merit a big pat on the back. After all, let us not forget that it was only a couple of months ago during the Q2 reporting season that, according to Bloomberg, c.70% of all S&P500 companies managed to surprise investors by beating expectations. Four weeks later, earnings forecasts and EPS momentum had collapsed. Number and percentage of S&P 500 companies “surprising” during the Q2 reporting season Sector

Positive surprises

Negative surprises

Percentage + surprising (%)

Oil & Gas

24

11

69

Basic Materials

20

6

77

Industrials

61

14

81

Consumer Goods

43

15

74

Health Care

39

7

85

Consumer Services

46

17

73 88

Telecommunications

7

1

Utilities

21

12

64

Financials

46

38

55

Technology S&P 500

36

23

61

343

144

70

Source: Bloomberg

As companies report, analysts systematically become more positive.

We have noted in the past how analysts’ upgrades and downgrades are linked to company news announcements. Not only is there a systematic increase in the amount of analysts’ changes posted (which is not particularly surprising), but there is also a marked increase in the percentage of upgrades posted versus downgrades. Below we update a chart we first produced several months ago showing the weekly number of news announcements by US companies, against the weekly ratio of upgrades/downgrades. As the reporting season kicks off, so the ratio of upgrades to downgrades rises. Equally, it tends to slump straight after, as it has done in recent weeks. The ratio of upgrades to downgrades systematically increase during the US reporting season 1200

1.8 1.6

1000

1.4 800

1.2

600

1.0 0.8

400

0.6 200

0.4

Upgrades/Downgrades (l.h.scale) Source: SG Quantitative Research, IBES

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9 October 2008

Number of earnings news announcements

Sep-08

Jul-08

May-08

Mar-08

Jan-08

Nov-07

Sep-07

Jul-07

May-07

Mar-07

Jan-07

Nov-06

Sep-06

Jul-06

May-06

Mar-06

0 Jan-06

0.2

Global Quantitative Strategy

Does the reporting season influence market performance? The chart on page 2 implies that during the reporting season, when confronted with all this “good” news, investors should feel more positive than at times when analysts are cutting their numbers during the intervening periods. We have therefore measured the performance of the S&P500 during and outside of the US reporting season from 2000 to 2008. Given that the Q4 year-end reporting season tends to be more dragged out, typically lasting 10 rather than five weeks (and no doubt more heavily audited), we have looked at the performance including and excluding this reporting round. The evidence suggests that average performance is higher during the reporting season

The evidence, albeit on a data set that only goes back eight years, shows that indeed average performance is typically marginally higher during the reporting season, particularly when the Q4 reporting period is ignored. Performance of the S&P during and outside of reporting seasons – 2000 to 2008 Avg weekly performance (annualised, %)

2.5 2.0 1.5

During reporting season

1.0

Outside reporting season

0.5 0.0 -0.5 -1.0 -1.5 -2.0 Including Q4 year end reporting

Excluding Q4 year end reporting

Source: SG Quantitative Research

This performance becomes even more pronounced when we examine the bear market periods between 2000-2003 and from August last year to date. Performance of S&P during and outside of reporting seasons – 2000 to 2008 (bear market only) Avg weekly performance (annualised, %)

If we focus on bear market periods, then the outperformance is even more pronounced.

2.0 1.0

During reporting season Outside reporting season

0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 -7.0 Including Q4 year end reporting

Excluding Q4 year end reporting

Source: SG Quantitative Research

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Global Quantitative Strategy

Conclusion We continue to believe that we remain in the middle of a prolonged profits slump. Earnings growth estimates remain too high for both this year and next – based on our calculations, Global ex-Financial consensus earnings growth still stands at a remarkable 11% for 2008 and 12% for 2009. These forecasts will ultimately need to come down, in our view. That said, with VIX futures up around the 45 level, markets down nearly 25% since August and relative strength indictors on the S&P500 dipping below 30 for the first time since mid-July, there will likely be many investors out there looking for a bounce in equities. The coordinated interest rate cuts yesterday were notable for their failure to inspire equity markets upwards. However, if the historical form of the US reporting season repeats itself, then this could provide the respite that some investors are looking for. With such a poor economic background, many investors may not want to be buying equities at the moment but, for the next few weeks at least, they may not want to be short either.

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Global Quantitative Strategy

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