A pattern has been firmly established for a few years now, whereby aggregating analysts’ forecasts at the beginning of the year produces an estimate of around 10% annual growth in EPS. With inflation low and economic growth below most estimates of trend, this figure is too much of a stretch for the average company to deliver and analysts then spend the rest of the year trimming their estimates. This is particularly prevalent in the run up to reporting season, when companies attempt to limit the damage to their share price by guiding expectations down, preferably to a level that they can then beat on the day of the numbers.

Across the S&P 500, 63% of stocks have negative EPS momentum over the last month, meaning that analysts have downgraded estimates for the company. This compares to only 50% with negative EPS Momentum over the past three months, showing that sentiment has deteriorated over the past four weeks. The P/E ratio of the downgraded companies is very similar to the median S&P constituent at 16.4x 12 months forward earnings, suggesting that fund managers have responded to earnings downgrades by selling stocks. The S&P 500 index is down a little over 1% over the past four weeks.

Among the hundreds of stocks that have been downgraded in the past month, 27 stand out because the downgrades have coincided with share price rises that are at odds with the rest of the names. One third of this smaller group of shares has had at least 1% cut from estimates, while the average P/E valuation of the stocks has risen to 19.3x, an 18% premium to the index. The table below shows these nine names, with those where earnings downgrades are among the highest in their sector flagged by a red arrow.

The table shows the shares that have outperformed despite being downgraded include index heavyweights, such as Bank of America and McDonald’s, where estimates have been cut 8% and 3% respectively over the past four weeks. Technology stocks Yahoo and Motorola are prominent on the list, as is KFC, Pizza Hut and Taco Bell owner Yum! Brands. All but one of these shares has also seen estimates cut over the past three and six months, yet only Motorola and Yum! Brands shares have not risen over this longer period. In the case of Bank of America, where the shares are little changed over the last half year, investors have seemingly disregarded downgrades to estimates of over one fifth. This reflects great faith that the fines and charges dragging down this year’s numbers are only temporary and that the ongoing investigations of the industry either pass by one of the largest banks, or cease altogether.

Over in Europe, where earnings season starts a little later than the US, 60% of the STOXX 600 names have been downgraded in the past month. EPS Momentum has been negative across the index for each of the last three months, in contrast to the US where it has fallen below zero only during September. Thus in Europe 66% of stocks were downgraded over the past three months, suggesting either that the situation is not getting any worse, or that companies have not yet got a handle on Q3 earnings and still have time to guide analysts down. The median P/E valuation of the index is 14.7x, 10% less than for the S&P 500.

35 stocks in Europe stand out for the degree to which a share price rally is at odds with downgrades and 14 of these have seen estimates cut by at least 1% in a month. The list includes one or two of the index bigger beasts, such as GDF Suez the French power supplier, but only one stock in Standard Life where downgrades have been among the largest in its sector.

Overall it appears that the impending earnings season in the US has forced analysts to take a more critical view of earnings prospects, with or without the help of company guidance. In a handful of cases investors have chosen to ignore these developments, either dismissing them as one off, or happy that collectively the investment community has discounted all the bad news. The bellwethers of Q3 earnings season in the US may well be the likes of Bank of America, McDonalds, Yum! Brands and Motorola, because these are the stocks where investors are taking the biggest bets against the collective wisdom of the analyst community.