Emerging Analyst Trend Could Be Positive for Stocks

A couple months ago, I wrote about analyst buy, sell, and hold recommendations on S&P 500 Index (SPX) stocks. After getting it wrong for a couple years as stocks rose, they finally started suggesting more buys over the past year. This week I’m looking at the same data but I’m comparing the data on large-cap S&P 500 Index stocks to how analysts view small-cap stocks as well. I think the findings are interesting.

The blue line in the chart below is what I talked about a couple months ago. It’s the percentage of analyst buy recommendations looking at stocks in the S&P 500 . The green line is similar data, but it looks at small-cap stocks in the S&P 600 Index (SPCY). Analysts have always tended to favor large-cap stocks but the spread between those two lines is getting wider.

This next chart shows the S&P 500 along with the spread between the analyst percent of buys for large caps and small caps. The larger the spread, the more analysts are favoring large-cap stocks. Note that in 2007, near the end of a multi-year bull market, the spread hit a low of nearly zero percent, meaning analysts were just as likely to recommend a small-cap stock as a large-cap stock. When the financial crisis hit, the spread spiked to the highest level on the chart.

This makes sense to me, since as analysts are more bullish on the market, they’ll be more likely to suggest a small-cap stock. The more confident that they are that stocks will rise, the more likely they are to suggest a small-cap, high-beta stock since those stocks will be expected to gain more in a rising market. When analysts are pessimistic, they’ll favor more defensive, low-beta, large-cap stocks.

Using the spread as a proxy for sentiment, the chart shows analysts are getting more bearish as stocks continue to move higher. Based on our contrarian philosophy, this is a bullish sign for stocks.