All Bets Are Off! – Analysing the markets in a time of crisis

Previously misperceived as having little impact on equity markets, the profession of financial analysis has since become viewed in an altogether more positive light. Market prices and volatility are increasingly influenced by the placing of institutional money, which is performed based upon buy or sell recommendations from analysts. Their job is to provide an independent voice of reason by identifying mistakes that other investors may make, ideally before they make them! Market volatility is one of the tests of this tricky business. Factor in the global financial crisis since 2008 and the job of making an accurate equity judgement call is harder than ever.

Analysis out of the window

The crisis period was marked by a strong influence of both buy and sell recommendations for both the Greek and German markets, “buy” having a significant negative impact and “sell” a significant positive one. What this point illustrates is that, in a time of crisis, the analyst becomes increasingly redundant as the nature of the crisis (whatever the health of the economy in question) governs people’s investment behaviour far more strongly than independent expert advice.

Generally speaking, recommendations to sell an organisation increase market volatility as they suggest that the time is right to cash in before the market situation may worsen. Buy recommendations are a little more complicated to call. They may reassure potential investors that now is a good time due to a rising market or, on the other hand, that things are about to get worse and so it’s “now or never”. Overall, though, analysts tend to make more buy recommendations than their sell equivalent. This model can be confidently applied during periods of market rises and falls. However, the Troika bailout crisis period has thrown these trends out of the window. To see to what extent, one of the worst-hit economies (Greece) has been tested in a recent study against one of those to have emerged relatively unscathed (Germany).

The Greek case is an especially useful one when attempting to observe trends through rise, fall and crisis periods as in their case they can be very clearly identified as running from 2002 to 2007 (rise), followed by 2007 to 2010 (fall), and then the crisis period of 2010-14. Whilst the German economy was by no means untouched by the crisis, setting the state of their economy against that of the Greeks offers a rigorous way of testing the impact of buy and sell recommendations in highly contrasting market conditions.

Both economies were analysed from the perspective of daily returns (i.e. changes in stock market prices) and skewness (meaning the likelihood of positive or negative returns from one day to the next). Of the many findings on the Greek side, one stand-out statistic was the jump in sell recommendations during the crisis to 60% of all recommendations, underlining the weakness of the economy from the bailout onwards. Another interesting trend to emerge was how relatively little non-financial sectors were impacted, despite the overall state of affairs. Financial institutions emerge as the main victims by a clear margin. The Greek results were then set against those from the German DAX30 index for the same periods and market return statistics, which displayed an overall stronger confidence in market recommendations.

Having been a more stable market for many years, the German results showed an overall confidence in sell recommendations pre-crisis, due to the relatively lower level of uncertainty involved in such operations, meaning the decision to sell was less significant as the market was generally more trustworthy. By contrast, in pre-crisis Greece sell recommendations impacted investors’ behaviour negatively during the fall period in particular as people became more uneasy about investing. In terms of buy recommendations, they were seen to reduce volatility in the rising stage in Greece but, a little surprisingly, no impact in the falling stage. In Germany, such recommendations increased volatility in a rising market but reduced it in falling market, acting as a form of calming mechanism.

In conclusion, then, market reaction to new information clearly depends on not just the state of the market but also feelings of uncertainty. The contrasting Greek and German examples show how such trends can form in the rise and fall stages in differing ways and impacted by learned recommendations. However, when a crisis hits, it’s anybody’s guess.

This article draws inspiration from the paper Analyst recommendations and volatility in a rising, falling, and crisis equity market, written by Michael Dowling, Shaen Corbet and Mark Cummins and published in Financial Research Letters volume 15 (2015).

Michael Dowling is an assistant professor of Finance and Accounting at ESC Rennes School of Business, France. His research interests include Asset Pricing, SME Financing, Behavioural Corporate Finance, Investor Psychology, and Energy Finance.