Investment analysts tend to be optimistic by nature. And anyway, it is easy to churn out glowing reports during ebullient times. But what happens when the markets start to display the erratic behavior witnessed over the last few weeks with prices hanging onto every snippet of news? Do they suddenly start blanking out chunks of their latest recommendations or rushing out completely new drafts?
Traditionally, sell-side research analysts have been reluctant to revise forecasts because there is a natural tendency to wait for the dust to settle. Also, it is difficult in temperamental times to find the right moment to revise estimates. For example, predicting the future is a challenge when global commodity prices continue to fluctuate, making it difficult to assess the true extent of the damage to regions like Latin America or sectors like oil and gas.
Sell-side analysts are also under pressure from internal forces, such as the corporate finance teams who don’t want to see existing or potential clients put on the watch list. And companies themselves may threaten to close off information channels. Lastly, investors – not surprisingly – want to see strong ratings maintained in their portfolios.
‘In a volatile market, there is a temptation to forget about fundamental research and be reactive,’ admits one research analyst. ‘It’s an emotional time but analysts mustn’t panic because portfolio managers are expecting and relying on you to guide them through the turbulence. Analysts must take a step back and be able to look clearly and objectively at a particular sector or set of stocks.’
Veteran vibes
Experience is also a helpful tool. ‘There’s a whole group of analysts and fund managers out there who never saw a bear market, not to mention the crash in 1987,’ notes one veteran analyst. ‘As a result, the complacency has been extensive and you can see it in the way the two groups initially reacted. The younger ones stared bug-eyed at their computer screens while the older ones were quick to pick up the phone to reassure their clients. They know how important it is to keep the lines of communication open and call clients to help them assess their portfolios in light of current events. Often, it is less of an advisory session than an exchange of information.’
This open door policy should not only be practised within the confines of the investment banking or fund management’s hallowed halls. Many analysts believe that the most successful companies are those armed with IR departments who can adroitly guide their organizations through difficult and choppy markets. As Albert Richards, head of European equity research at Salomon Smith Barney, points out: ‘Investor relations directors may not have control over outside events, but they have to be diligent about detailing exposure.’
If they are not, their share price will suffer. ‘Nothing upsets an analyst more than being caught out,’ notes John Harbord-Hamond, head of UK equities at Cazenove in London.
‘The IR officer’s job is to manage expectations and be careful not to talk the story up or down,’ concurs Neil Cooper, European market strategist at BT Alex Brown. ‘What the analyst is looking for more than anything else is an honest evaluation of the situation. At the end of the day, investors and brokers like – and will reward – transparency. For example, if there is bad news, it will tip the market, but not as much as a nasty surprise.’
Direct delivery
Truthfulness is only one part of the equation; delivery is the other. ‘The demands made on investor relations departments will increase in times like these as they do on us,’ says one analyst. ‘We want timely responses to fast changing situations and IR people should be prepared. The line of questioning may be a bit more aggressive – especially if the company has exposure to the troubled spots of the world. Also we’re asking for more access to senior management so the chief executives should be ready to put their golf clubs away during the weekend and come into the office if events dictate.’
Bob Haville, director of research marketing at Merrill Lynch in London, believes uncertain markets can be the making of an IR department. ‘It is when they come into their own. If they have done their homework and secured relationships, they can put all their contacts to work and effectively communicate their message,’ he says.
For analysts, things are not looking very different. Fundamental research remains paramount. ‘The analytical process is basically the same,’ according to Haville. ‘Analysts must take a measured view and should not respond to unexpected events with knee-jerk reactions. I think there is a more heightened sense of awareness during these periods but good analysts are constantly re-examining the assumptions their earning projections are based upon and are fully aware of the threats and opportunities to the companies and sectors they follow.’ Right now, one such threat is the exposure of companies to areas like Russia, Asia and Latin America. ‘We look carefully at all their business exposures starting from where they are located to their export levels, contracts, and business practises to see if we should make any meaningful adjustments,’ Haville adds.
Stick to basics
Francois Langlade-Demoyen, head of European equity strategy at Credit Suisse First Boston in London, believes that the most important thing is to stay calm in such conditions and stick with high quality analysis. ‘Portfolio managers expect and rely on you to step back and look carefully as well as objectively at the different downside risks and where fair value in the market exists,’ he explains. ‘It is important not to get carried away with the emotion of the moment but to do the fundamental analysis to understand why there is turbulence and what is the trigger.’
Langlade-Demoyen favors an economic value added model which measures and calculates the economic profitability of companies. ‘We use the model not because it is a nice intellectual exercise but because the market is tied to economic profitability,’ he says. ‘However, in times like these, we also conduct more sensitive analysis, which factors in different scenarios and the impact they will have on the different regions, sectors and companies.’
And while the basics – a company’s track record, the strength and character of its management team, business strategy and crisis management tactics – are still at the forefront, many investment houses also turn more to the big global macroeconomic picture. ‘Economists and strategists come more to the fore,’ explains Paul Krickler, marketing director for research at Goldman Sachs in the UK. ‘Their guidance is more sought after and they work with the analysts to determine the impact turbulent markets are having on different economies, currencies and exchange, interest and inflation rates. All these factors are feeding into the stock market. For example, suppose the US dollar plunged, then analysts could pinpoint the strong exporters who would benefit.’
As Harbord-Hamond points out, one of the most important factors is the management’s track record – that should give an indication of how they will cope under more difficult conditions. ‘We’re also interested in a company’s competitive position in its industry, its cash flow and the strength of its balance sheet. But in a time of uncertainty, you have to factor in the macroeconomic perspective.’
One of the main problems, though, is that few forecasters are willing to place their bets on which way the market is going to turn. While some view the current volatility as a sign of a more sinister bear market, others feel it is just that much needed correction that many experts had been predicting.
‘At the moment no-one can quantify the risks and until we have more visibility it is a difficult call to make,’ says Cooper of BT Alex Brown, which called the start of the market downfall in July. ‘We all have theories but investors must use sensible caution. For example, they should avoid the companies that are vulnerable and keep the defensive stocks, even if they are more expensive. They are the ones that will rebound when the market bounces back.’
