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Bullish analyst calls can spell doom for U.S. stocks

A board overlooking the floor of the New York Stock Exchange shows an intraday number above 1,600 for the S&P 500, Friday, May 3, 2013.

Richard Drew/AP

The S&P 500 is relatively flat this year after four months of fits and starts, leaving strategists to conclude that we're seeing a rotation out of expensive stocks with big growth potential and into cheaper stocks with less dazzling futures.

But consider this alternative theory: Investors are rebelling against analyst enthusiasm.

Bespoke Investment Group published a report on analyst coverage for the S&P 500 earlier this year, listing the most popular stocks and sectors based on analyst "buy" and "sell" recommendations.

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Now, a third of way into 2014, the takeaways are clear: Ignored sectors are hot and a rising number of bullish calls on individual stocks in the S&P 500 can spell doom.

While mocking analysts has long been a popular sport among some investors, the clear division between popular and unpopular stocks fits remarkably well into the changes now occurring within the stock market.

According to Bespoke, there are an average of nearly 24 analyst ratings per stock in the S&P 500.

The most popular sector? That would be technology, which boasts a team of nearly 30 analysts per stock, most of whom are very bullish. About 53 per cent of their recommendations are "buys" versus just 7 per cent that are "sells."

Unfortunately, the technology sector hasn't been dazzling anyone this year, with weak performances from the likes of Google Inc., Yahoo Inc. and MasterCard Inc.

Consumer discretionary stocks are also popular among analysts, but the sector has fallen nearly 5 per cent this year, marking the worst performance of all 10 subindexes in the S&P 500.

On the other hand, the least popular sectors – or those that have the fewest number of analysts covering them and a relatively low number of "buy" recommendations – have stood out with fine returns.

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Utilities are the loneliest group, with an average of just 18 analysts per stock and "buy" recommendations accounting for a mere 35 per cent of their calls, which is dismal.

Yet utilities have risen nearly 14 per cent this year, leading all other subindexes in the S&P 500 by a wide margin.

As for consumer staples – the dull, predictable companies within the consumer universe – they lag the consumer discretionary sector in terms of analyst coverage and "buy" recommendations. Yet, staples have outperformed the discretionary sector by more than seven percentage points.

Individual stocks show a similar trend.

Near the start of the year, Bespoke listed stocks in the S&P 500 that enjoyed the biggest change in the number of "buy" recommendations from analysts, year-over-year, along with stocks that suffered the biggest change in "sell" recommendations.

You probably know where this is going: When analysts changed their minds, stocks moved against them.

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The five stocks with the biggest increase in bullish enthusiasm were Mohawk Industries Inc., Best Buy Co. Inc., Perrigo Company PLC, Weyerhaeuser Co. and Sherwin-Williams Co. The number of bullish analysts with "buy" recommendations surpassed 75 per cent in the case of Mohawk and Weyerhaeuser.

However, four of the five stocks are down this year, with an average decline of 9.8 per cent, vastly underperforming the S&P 500. Best Buy is a standout, falling more than 35 per cent.

The five stocks that saw the greatest number of analysts turning bearish were Deere & Co., CH Robinson Worldwide Inc., Intuitive Surgical Inc., Exelon Corp. and Clorox Co. The number of "sell" recommendations surged above 25 per cent in all cases, which is very high given the average for all S&P 500 stocks is less than 7 per cent.

However, the market didn't pay heed: These stocks have risen an average of 4.6 per cent this year, or more than double the performance of the S&P 500. Exelor, with no "buy" recommendations at the start of the year, has surged more than 26 per cent.

But watch out: Analysts are now warming up to it.

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About the Author
Investing Reporter

David Berman has been writing about business and investing since 1995. He has written for a number of magazines, including Canadian Business and MoneySense. He worked at the Financial Post as an investing writer and daily columnist before moving to the Globe and Mail in 2008. More

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