Macquarie -- Lessons from the conviction index:: Stand up and be counted

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Microstrategy Minute
Lessons from the conviction index
Stand up and be counted
 Equities market participants are not often short of an opinion. However, in
recent weeks, as China’s response to accelerating inflation grabbed
headlines, tensions rose on the Korean peninsula, and the Irish ran out of
luck, it appears conviction has grown harder to find.


 Since the bear market ended in Q109, analysts have grown more willing
to take a view. The ‘Conviction Index’ (i.e. the ratio of Buy plus Sell
recommendations to Total recommendations) for the MSCI Asia Index
reached a low in March 2009 – and steadily increased to its highest quarterend
value as of end-June 2010 (Figure 1).

 The conviction level slipped in recent months, however. This is not
surprising with valuation metrics trending back towards historical averages,
and the macro view becoming even more complicated. We continue to
suggest sticking to your stripes – with recent gyrations offering a tactical
buying opportunity as the outlook for macro drivers continues to firm.
Perma-bears and -bulls melting in places

 Entrenched analytical biases. In some markets, it is consistently easier to
find a bull and in some it is easer to find a bear – although it appears some of
their typical habitats are changing. Over the past five years, about 55% of
analyst recommendations have been positive (i.e. a Buy or Outperform call,
depending on the house). In Korea and Thailand, however, this ratio of
positive calls has consistently been higher (with no sign of abating): in both
markets, over 75% of analyst calls are currently Buys!

 Sell ideas have not been easy pickings. Only 15% of analysts’
recommendations across Asia suggest a negative outlook. Surprisingly,
though, the markets with the fewest positive recommendations are not where
one finds the highest concentration of negative recommendations. Analysts
covering Japanese stocks, for example, have consistently had a belowaverage
ratio of positive calls in Asia, yet this does not translate to a higher
number of negative calls. In fact, analysts covering Japanese stocks have
also consistently had a lower ratio of sell calls than the market average –
indicating, simply, lower conviction overall. Analysts covering stocks in
Malaysia and Hong Kong, by contrast, have been most willing to suggest that
they are a sell over the past five years.

 Analysts in some markets changing their spots. Until March 2009,
analysts covering Indian stocks were a steadfast source of positive calls; but
more recently, they have switched to providing consistently more negative
views: Currently 18% of analyst recommendations for Indian companies are
negative – the second highest in Asia after the Philippines (which has also
transitioned away from more positive calls). Japan, on the other hand, has
seen a shift toward more positive calls recently – with the ratio reaching its
highest quarter-end number in five years as of September.

Differences aside, analyst views are…useful!
 While biases between markets are clear, dare we say that analysts’
recommendations have been a useful signal for investors. Work by the
Macquarie Quant team in their latest Dynamics (12/11) suggests revisions to
analyst recommendations generated an information coefficient of over 10%
during October/November.