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What's Worse Than Overestimating a Gain?
(Hint: An Estimate That Amounts to the "Biggest Miss Ever)
If there's anything worse than overestimating a gain, it would be underestimating a loss. And when someone manages to do both at the same time, well, the only explanation for a twin blunder of that sort is an "estimate" which completely misses a major turn in the trend.
Such was the case in the average quarterly earnings estimate among Wall Street's 1,800 equity analysts, not only for Q4 of 2007, but for the quarter before that as well (Q3, 2007).
That is to say, the overwhelming consensus of Wall Street's analytical opinion was bullish on earnings regarding the entire second half of 2007. As Q3 began, the average estimate was for an earnings gain of 5.7%, though by that quarter's end the estimate was cut to a 2.7% gain. The actual final earnings report showed a 2.5% decline.
Undeterred, analysts began Q4 with an average estimate of 10.9%, though by that quarter's end the estimate was cut to a 7.9% decline. The actual final earnings report showed a decline of 22.6%. That's an overestimate of 33.5 percentage points, which Bloomberg described as "the biggest miss ever."
All of this (and more) is noteworthy in light of today's media stories about the start of "earnings season" for Q1 of 2008 -- which, once again, began with Wall Street's analytical opinion bullishly undeterred by the experience of the previous two quarters.
Now, this is not to single out equity analysts -- every person and even every profession that involves forecasting will go through periods they'd just as soon forget. That said, the financial and economics establishments still regularly go wrong for pretty much the same reason, which is that their forecasts are linear -- they base their view of the future directly on the recent past. And when earnings have shown a profit for more than four consecutive years (2003-2007), equity analysts almost reflexively speak with one voice in expecting more of the same, even when they've been embarrassingly wrong for two quarters.
This means, of course, that it's all but impossible for them to catch a major turn in the trend -- and also means that it's a near certainty that they will overestimate gains and underestimate losses. On the other hand, Elliott wave analysis (and technical analysis generally) expects markets (and investors) to be nonlinear...
...Because they are.
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