Academic journal article Journal of Financial Management & Analysis

Impact of Fed's Monetary Policy Stance on Analyst Coverage-Cum-Revisions : The U.S. Economy in Perspective

Academic journal article Journal of Financial Management & Analysis

Impact of Fed's Monetary Policy Stance on Analyst Coverage-Cum-Revisions : The U.S. Economy in Perspective

Article excerpt

Introduction

in the future.

In this paper, we examine the relation between Fed's monetary policy stance and analyst coverage, analyst recommendations, and revisions in the U.S. We know from previous studies that both analyst coverage and analyst recommendations have a significant impact on stock returns (Barber, et al1., Stickel2, Womack3, Barron, et al4., and Chan and Hämeed5). Stocks that are covered by more analysts (i.e., high coverage stocks) and stocks that receive more favorable scores tend to have higher returns Since analyst coverage and recommendations are important to the investors, it would be crucial to know the factors that affect them. Several previous studies have examined the impact of firm characteristics on analyst coverage and recommendations, but to the best of our knowledge, there is no study on the relation between monetary policy and analyst coverage/ recommendations. Since macroeconomic policies including the monetary policy have an impact on firms' revenues, expenses and profits, stock analysts should control for them when forecasting firms' future cash flows, earnings and dividends. When the Fed is following a more accommodative (i.e., expansionary) policy, we would expect stock analysts to forecast a relatively brighter future for the firms that they are covering (hence better recommendation scores) during these periods. We would also expect more upward revisions and fewer downward revisions when the Fed is more accommodative.

If that is the case, a recommendation score of "3" shouldn't be interpreted in the same way when the Fed is trying to grow the economy versus when it is trying to cool down the economy. Also, in that case, an upward revision for a firm in an expansionary policy period should not be regarded as highly as an upward revision in a contractionary policy period. In other words, if monetary policy significantly affects analyst coverage/revisions, we will need to interpret the recommendation scores, the upward/downward revisions, and the number of analysts following each firm differently in expansionary and contractionary policy periods. If there is a significant relation between monetary policy and analyst coverage and/or recommendations, it will have implications for future research. All future research that examines the relation between analyst recommendations/ coverage and stock prices will have to control for the monetary environment.

Prelude

Several studies have examined the relation between analyst forecasts (and coverage) and stock returns. These studies have shown a significant relationship between analyst forecasts (and coverage) and stock returns. Stickel and Womack show that favorable changes in individual analyst recommendations are accompanied by positive returns at the time of the announcement. They also show that unfavorable changes in recommendations are accompanied by negative returns. They also show a price drift that may continue up to six months after the announcement, meaning that prices slowly adjust.

Later, Barber, et al. examine whether it is possible to profit from various investment strategies using publicly available analyst recommendations. They find that purchasing stocks with the most favorable consensus recommendations yield annual gross abnormal returns exceeding four percent, if the portfolios are rebalanced daily and if a timely response is given to recommendation changes. They show that similar gross abnormal returns can be made by short-selling stocks with the least favorable consensus recommendations. However, since their strategies require frequent trading, the transaction costs are high. After accounting for these costs, they find that none of their strategies generates a positive abnormal net return.

Barron, et al. attempt to find out whether the relation between dispersion in analyst forecasts and stock returns is positive or negative, and which of the two variables, i.e. uncertainty and lack of consensus, causes the dispersion. …

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