When they are wrong about quarterly earnings forecasts, analysts may stubbornly stick to their erroneous views, a tendency that might contribute to market bubbles and busts, according to research coauthored by John Beshears of the Stanford Graduate School of Business.
So far it looks like green jobs aren't delivering as advertised due to cheaper costs in China.
Here are the top financial stories of the day:
1) Stocks rise slightly on earnings reports-From the AP
Stocks rose modestly Wednesday after companies reported higher earnings but gave mixed forecasts about how the fragile economy and rising costs will affect their growth.
Target Corp., Staples Inc. and Dell Inc. reported earnings for last quarter that were above analysts' forecasts. Companies in the Standard & Poor's 500 are on track to report higher profits for a ninth straight quarter. But economic growth is weak around the world, and some economists worry that a second recession may be coming. That could hurt companies' earnings in the future -- and kept investors from buying with more enthusiasm Wednesday.
Dell's forecast added to investors' concerns: It cut its prediction for revenue growth this year. Target and Staples gave profit forecasts that were above Wall Street's expectations.
The Dow Jones industrial average rose 4.28 points to 11,410.21. The S&P 500 rose 1.12, or 0.1 percent, to 1,193.88. The Nasdaq composite fell 11.97, or 0.5 percent, to 2,511.48.
Seven of the 10 sectors that make up the S&P 500 rose. The biggest drops came from technology stocks, which fell 0.8 percent after Dell cut its forecast.
"There are a whole bunch of contradictory signals in the system now, and it's hard to tell which way to go," said Charlie Smith, chief investment officer of Fort Pitt Capital Group, which has just over $1 billion in assets under management.
Investors are still worried about Europe. Some countries have borrowed so much that they may not be able to repay their bonds, and economic growth there has slowed. Concerns about a possible default by a
European country have dominated the market in recent weeks, along with worries about the slow U.S. economy.
Another concern Wednesday: Companies are contending with rising costs. Higher food prices helped push inflation at the wholesale level to 0.2 percent in July, according to a government report Wednesday. That compares with a 0.4 percent drop in June, but is still well below inflation levels earlier this year when violence in the Middle East forced oil prices higher. In February, wholesale prices rose 1.5 percent.
Economists say rising inflation reduces the chances that the Federal Reserve could announce another round of bond purchases to help the economy, a move called quantitative easing. The Fed just ended its second round of purchases, known as QE2, in June. "QE3 could be a hard sell" given higher inflation, Credit Suisse economists wrote in a report. They expect the government on Thursday to report that consumer prices rose 0.2 percent in July.
Preppy retailer Abercrombie & Fitch Co. fell 8.7 percent after its CEO warned of challenges ahead -- including higher expenses. Cost "pressures will be greater in the second half of the year, and macroeconomic uncertainty has increased," Mike Jeffries said, after the company reported a 64 percent rise in profit last quarter.
Dell said late Tuesday its profit rose 63 percent last quarter on strong demand from businesses and government agencies. But it also cited "a more uncertain demand environment" when it cut its forecast for annual revenue growth to a range of 1 percent to 5 percent. That's down from an earlier growth forecast for 5 percent to 9 percent. Dell stock fell 10.1 percent Wednesday.
Other companies are more optimistic. Retailer Target said it expects to earn between $4.15 and $4.30 per share this year. Analysts expected $4.14. Target also said its earnings last quarter rose 3.7 percent on sales of grocery, beauty products and other items. Target stock rose 2.4 percent.
Office products retailer Staples raised its profit forecast for the year after saying strong international sales pushed earnings up 36 percent last quarter.
Deere also raised its forecast for full-year earnings. It now expects to earn $2.7 billion this fiscal year, up from a May forecast of $2.65 billion. The maker of tractors and other heavy equipment said its profit rose 15 percent last quarter on strong demand for farm equipment.
Stocks have been particularly volatile in August. Worries rose as the U.S. government said it may default on its debt unless it was allowed to borrow more. The government just beat the deadline to avoid a default, but the partisanship in the debate came at a cost -- Standard & Poor's downgraded the U.S. credit rating on Aug. 5 by one notch to AA+ from the top AAA rating. That triggered one of Wall Street's wildest weeks: The Dow rose or fell by at least 400 points in each of the first four days of last week, the first time that has happened.
Markets appear to have calmed somewhat since then. Tuesday marked the first time since the Aug. 5 downgrade that the Dow rose or fell by less than 100 points. It fell 76 points on worries about Europe's ability to contain its debt problems.
Nearly three stocks rose Wednesday for every two that fell on the New York Stock Exchange. Consolidated trading volume was relatively light at 3.9 billion shares, the lowest in three weeks.
2) When They Are Wrong, Analysts May Dig in Their Heels-From Stanford Graduate School of Business
Like oracles in the stock market, securities analysts come up with earnings estimates that are supposed to signal the worth of a company's stock. But what happens when a company's actual performance proves an analyst's quarterly forecast is wrong?
Instead of fully incorporating new information into their forecasts, many of those analysts stubbornly stick to their erroneous views on the company, a tendency that might contribute to market bubbles and busts, according to recent research.
Analysts who make "extreme" quarterly forecasts — above or below the consensus or median estimate among all analysts following a given stock — tend to dig in their heels after being proved wrong, says John Beshears, an assistant professor of finance at the Stanford Graduate School of Business and coauthor of research exploring the phenomenon of stubbornness among stock analysts. Once a company reports quarterly earnings showing the analyst was too optimistic or too pessimistic, the extreme incorrect analyst will revise his or her full-year forecast, but will move less aggressively in the direction of the earnings surprise than other analysts.This stubbornness hurts an analyst's overall forecasting accuracy, say the researchers.
So what's behind the stubborn streak?
"People become overcommitted to a previous course of action," says Beshears. "Psychological factors like this play an important role in how people form expectations about the future."
Beshears and Katherine L. Milkman of the Wharton School at the University of Pennsylvania looked at how so-called "escalation bias" affects analysts' forecasts. Their paper, "Do Sell-Side Stock Analysts Exhibit Escalation of Commitment?" was published in March by the Journal of Economic Behavior and
Organization.
The research has broader implications for understanding financial markets. Persistent, widespread over-optimism or over-pessimism by market participants could lead to mispricing of assets, says Beshears. He suggests, for example, that stubbornness contributed to the financial crisis of 2007-2008. Despite initial signs of a weakening real estate market, many analysts, investors, and lenders maintained or stepped up their commitment to housing-related assets, such as mortgage-backed securities. The result: The housing bubble continued longer than it should have, delaying and exacerbating the subsequent bust. Stubbornness, Beshears says, "is one mechanism that might allow market bubbles and crashes."
The study underscored the importance of psychological biases in shaping market participants' behavior. Previous research showed that when people make decisions that turn out to be wrong, they try to justify them. They may have invested time, money, and effort into a decision, so they want to recoup their "sunk costs." Hence, they are reluctant to back down. "They want to recover their costs" and "hopefully vindicate themselves," says Beshears, who researches how individuals and companies make financial decisions.
Securities analysts go out on a limb when they make extreme profit estimates. So when their quarterly forecasts are proven incorrect, these analysts adjust their full-year estimates less to coincide with fact than analysts who started at the quarterly consensus, according to the research.
Consider an analyst who forecasts quarterly earnings of $1.10 a share and a second analyst estimating $1.00 a share, which matches the consensus or median estimate. Suppose the company reports earnings of only 90 cents a share. The first analyst is wrong by 20 cents and the second analyst is wrong by 10 cents a share. Both would then revise their full-year forecasts downward, in the direction of the earnings surprise. The researchers found that the analyst who was more extreme in the wrong direction revised his or her full-year estimate by less than the second type of analyst.
Beshears and Milkman studied the Institutional Brokers' Estimate System I/B/E/S database with more than 6,200 analysts' quarterly forecasts on about 3,500 companies over more than 18 years, from 1990 to 2008. They created variables such as how far off a quarterly estimate was from reported earnings, how far off an estimate was from the consensus forecast, how much a full-year estimate was revised, and how accurate a full-year adjusted estimate turned out to be. Using statistical techniques, they looked at how the variables moved together or separately, discerning patterns in the analysts' forecasting and updating behavior.
Among their specific findings:
- As analysts got more and more extreme, or "out-of-consensus," they became less and less responsive to the new earnings information when revising their full-year forecasts.
- Stubbornness hurts forecasting accuracy. Revised full-year forecasts from extreme incorrect analysts were further off the mark from actual earnings than they would have been had the analysts' updating behavior been like the behavior of analysts who started at the consensus point.
- Analysts are punished for stubbornness. The more extreme, incorrect, and stubborn an analyst was, the less likely that he or she would rank among Institutional Investor magazine's "All-American" list of top analysts.
He believes research on escalation bias can be extended from equities to the debt markets to shed light on how credit analysts, loan officers, or risk management experts, for instance, view the performance of financial assets. Another future direction would be creating an "overarching model" of the psychological biases at play when people form expectations about the future or make financial decisions, he adds
3) Overrun by Chinese Rivals, U.S. Solar Company Falters-From The Wall Street Journal
Evergreen Solar Inc., once a darling of the U.S. solar industry, filed for bankruptcy protection this week, saying it couldn't compete with Chinese competitors without a reorganization—a sign of the difficulty in creating "green" U.S. manufacturing jobs amid bruising competition across the globe.
The market for solar panels is expanding world-wide. But the key thing driving demand is increasingly lower prices, which is forcing U.S. firms into a cutthroat cost-cutting war with rivals in China and elsewhere.
"When margins are getting squeezed, pennies count," says Pavel Molchanov, a solar analyst with Raymond James Financial. "Quite frankly, as a solar manufacturer, it is a lot better to pay workers $1 an hour in China than workers $15 an hour in Massachusetts."
The average price of solar modules has fallen 30% this year, after declining steeply last year, he said.
Evergreen declined repeated requests for comment.
Earlier this year, Evergreen closed its Massachusetts factory, a $450 million facility that opened in 2007 with support from state and local subsidies and employed about 800 workers. One of its largest creditors is MassDevelopment, a state agency, according to the bankruptcy filing.
Evergreen began to manufacture panels in Wuhan, China, last year. Other U.S.-based solar companies have already moved their production overseas: SunPower Corp. to the Philippines and First Solar Inc. to Malaysia.
In its Chapter 11 filing, Evergreen cited the difficulty in competing against Chinese solar companies that "receive considerable government and financial support."
It also blamed reductions in European subsidies for solar installations and what it called the U.S.'s failure to adopt supportive policies.
But while low-cost Chinese competition may have accelerated the collapse of the company's balance sheet, Evergreen also bet on the wrong technology.
Evergreen developed a technology that uses less polysilicon —a material housing small silicon crystals—than its competitors. When the cost of this raw material reached $400 per kilogram in 2008, Evergreen's solar panels were competitive. Evergreen's share price closed at a split-adjusted $108 in January 2008, its highest level in more than seven years.
Since then, polysilicon prices have plummeted to about $55 a kilogram. This has stripped away Evergreen's competitive edge and left it with a higher-cost manufacturing process. Its share price steadily fell since 2008, closing Tuesday at 16 cents on the Nasdaq Stock Market.
"As polysilicon got cheaper, this company could not compete with standard technology, which is getting cheaper weekly," says Jesse Pichel, global head of cleantech research at Jefferies & Co.
Chinese solar manufacturers enjoy extensive support from government industrial policy. They benefit from inexpensive capital, low-cost electricity and real estate, as well as less-expensive labor, says Mr. Pichel.
The global solar industry is growing quickly, in part because of government subsidies to promote clean-energy production and because of falling panel prices.
The annual production of solar photovoltaic cells reached 24 gigawatts in 2010, more than double the figure for 2009, according to Ren21, an international, government-supported institute that supports renewable-energy development.
The Obama administration has also supported "green" jobs as a future economic engine and has highlighted the solar industry. Its track record has been mixed,. Solyndra, a California-based solar-products maker, received a $535 million federal loan guarantee in 2009, but in late 2010 it announced plans to shutter an older plant and lay off workers.
Evergreen listed $424.5 million in assets in its filing with the bankruptcy court in Delaware, and debt of $485.6 million. It said it intended to shutter its facility in Midland, Mich., in the "near future." It also plans to lay off 83 workers in Massachusetts and Michigan, retaining 50 employees to help with the bankruptcy and reorganization process.
The company plans to reorganize operations with an emphasis on building up its China-based manufacturing facility.
Quote of the Day from Dave Ramsey.com:
Disgust and resolve are two of the great emotions that lead to change. — Jim Rohn
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