Three-Factor model gauges analyst sentiment, earnings trends and stock correlationsResearch from the new Wall Street Mood Monitor produced by 361 Capital
DENVER, July 24, 2019 /PRNewswire/ — Following a U.S. earnings hot streak that has persisted for 10 of the past 12 quarters through mid-2019, Wall Street analysts remained doubtful the trend would continue in the third quarter of 2019 and beyond, according to the new Wall Street Mood Monitor produced by 361 Capital, a Denver-based boutique asset manager.
The 361 Capital Wall Street Mood Monitor is a three-factor model that gauges the climate or “mood” for active management during a particular quarter within each economic sector. The factors are: analyst sentiment, earnings trends and stock correlations.
Read the full second-quarter 2019 Wall Street Mood Monitor here
Impressive Earnings Since 2016
“U.S.-based businesses have delivered mostly impressive earnings results since 2016, yet sell-side analysts don’t believe this streak can continue and they’ve felt this way for some time,” said John Riddle, CFA, chief investment officer for 361 Capital. “Only once in the past 10 months have positive analyst revisions outpaced negative ones.”
“We also look at intra-market stock correlations, measuring the returns of each stock in the grouping relative to the average return of all stocks in the universe,” Riddle said. “When correlations are high, stock pickers often struggle because returns across the market move similarly. At June 30, correlations were at 0.51. That’s below their long-term average of 0.55, and a positive indicator for stock pickers, compared with higher correlations of 0.60 in the first quarter.”
At the sector level, 361 Capital said conditions for active managers appear to be best in Communications Services, where correlations are lower relative to the long-term averages than any other sector in the large-cap Russell 1000 Index.
In the second quarter, 53 percent of U.S. large cap companies, as measured on the Russell 1000 index, reported an earnings surprise, up from 49 percent in the first three months of 2019. Meanwhile, only 12 percent of companies reported an earnings disappointment, slightly less than the 15 percent in the prior quarter.
The gap between the percentage of companies reporting positive earnings surprises vs. those reporting disappointments has grown consistently wider for the better part of the last four years, and hovers near 15-year highs achieved in September 2018.
Wall Street Sentiment
Businesses have delivered impressive earnings results, yet Wall Street analysts doubt this trend will continue.
In June, the negative revision rate exceeded the positive revision rate by 31 percent. That’s the worst mark since January 2016. The highest negative revision rates were in some of the most cyclical sectors: Materials, Energy and Industrials. The Health Care and Real Estate sectors were the only ones in which positive revisions outnumbered negative revisions.
Intra-market correlations now hover near their long-term averages but for active managers, that’s a reprieve from the prior quarter. During periods of high correlation, stock returns tend to move in tandem which reduces the opportunity for active manager to add value through superior selection. As market volatility ebbed and the prospects of accommodative Fed policy improved, correlations came down from 0.60 at the end of March to 0.51 at the end of June. That level is slightly lower than the long-term average of 0.55.
Intra-sector correlations are significantly below long-term averages in the Communication Services and Consumer Staples sectors. Meanwhile, Technology and Health Care intra-sector correlations remain considerably above long-term averages.
Intra-market correlation measures the average correlation between the returns of each stock in the grouping relative to the average return of all stocks in the universe. Intra-sector correlation measures the average correlation between the returns of each stock in a sector relative to the average return of stocks in that sector.
The Sector View
Health Care was one of only two sectors in which Wall Street sentiment was high, as 55 percent of all analysts’ changes to earnings estimates were upward revisions. Earnings trends for the sector were also strong: Fifty-nine percent of health care companies reported an earnings surprise in the second quarter, while only 7 percent reported an earnings disappointment. Only the Information Technology sector enjoyed a wider gap between the percentage of companies reporting earnings surprises and disappointments.
The lone sore spot for active management conditions in the Health Care sector is correlations. For the second consecutive quarter, no sector experienced higher intra-sector correlations relative to its long-term average.
The most notable trend in the Communication Services sector is the sudden surge in earnings strength.
Low intra-sector correlations within the Communications Services sector also offer potential for active managers. The sector is currently experiencing lower correlations relative to its long-term averages than any other Russell 1000 sector. However, sentiment toward the sector is low, as 60 percent of all changes to analysts’ earnings estimates within the sector were downward revisions.
About 361 Capital
361 Capital is a leading boutique asset manager. Founded in 2001, the firm offers a suite of actively managed alternative and behavioral-based equity strategies that seek to deliver meaningful alpha, manage risk and offer diversification potential to investor portfolios.
361 Capital is majority employee-owned with strategic investments from Lovell Minnick Partners, a private equity firm, and Lighthouse Investment Partners.