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The Rise of the Ax-Wielding, Market Moving Analyst


A thoughtful review of both the role and impact of stock analysts on financial markets.


Analyzing the Analysts

"In a bull market, who needs 'em? And in a bear market, they'll kill ya."

Famous financier Roy Neuberger said many memorable things in a 107-year life that only ended in 2010, apparently including the above quotation often attributed to him. It may in fact be apocryphal, but certainly makes good copy, and speaks to the cynicism many members of the public and investment professionals have toward equity analysts.

Sell-side research is again under fire following Facebook's (FB) botched IPO, with lead underwriter Morgan Stanley (MS) accused of tipping off its large banking clients to slowing growth rates at the social networking site long before individual investors were ever apprised.

Such shenanigans stand in direct violation of the Security & Exchange Commission's Regulation 'Fair Disclosure' rule forbidding selective dissemination of information that came into effect following 2000's tech wreck, the bursting of a bubble many claim was inflated by analysts who acted as little more than stock-peddling shills for the companies they covered.

This, then, is an opportune time to review both the role and impact of stock analysts on financial markets.

In the Beginning

The origins of modern Wall Street research are often traced to the 1959 founding of now-defunct investment bank Donaldson, Lufkin & Jenrette. For most of its history the field was seen as a sleepy librarian-like backwater, far removed from the glitterati of investment banking.

The role of an analyst was to investigate a company or industry in relative obscurity, forensic accounting and all. They would examine and number crunch with all the intensity of a Talmudic scholar, issuing a report only once it had been carefully vetted for potential conflicts by internal compliance and legal departments.

Seeds of Change

This geeky anonymity began to evaporate on May 1, 1975 when the SEC abolished fixed commissions. The ruling ushered in a sea change on Wall Street, which could no longer rely on formerly fat margins. With income shrinking at a stroke, firms had to find new ways to compensate expensive analysts, especially since research departments by themselves were cost, not profit, centers.

Pure research no longer paid for itself, so expenses were slowly spread among sales, trading, and investment banking. Strict legal 'Chinese walls' separating the departments were purportedly put into effect, at least in the US. (In Europe it is not at all uncommon to see researchers sitting on trading desks. And Chinese walls are ironically most lacking in China itself, where markets are more fledgling, rules looser, and analysts typically far less seasoned than their Western counterparts.)

Sell side analysts increasingly became stock pushers as they wore ever more hats. They were required to be bankers, salesmen, stars, and even -- with the advent of CNBC and its ilk -- television celebrities.

Research's role changed dramatically as Wall Street itself changed. The game became increasingly global and now catered primarily not to the average retail investor but rather enormous institutions and their vast potential riches.


This process reached its peak in the market mania and Internet boom of the late 1990s, when bullish research recommendations brought in billions in investment banking fees.

The mousy green eyeshade gumshoes of yore were now bona fide rock stars, gurus who could send stocks soaring with a single positive pronouncement. And positive they invariably were. At the height of the bubble, 100 "Buy" recommendations existed for every lonely "Sell," which even now remains a four letter word for many firms.

Ironically however, during the market's dot com millennial madness, "Sells" were actually reliable contrary indicators. Indeed University of California and Stanford academics looked at almost 40,000 equity recommendations from the year 2000, and those assigned inferior ratings actually outperformed their frowned-upon counterparts by 80 percentage points. (Eleven years later, the stodgy utilities sector had the lowest percentage of analyst "Buy" recommendations, despite being the single best performing industry of 2011.)

Meanwhile salaries for the field's most prominent practitioners reached a previously unimaginable eight figures. Morgan Stanley's Mary Meeker was anointed "Queen of the 'Net" by Barron's in December 1998 while Streets Wall and Main each eagerly awaited the latest upbeat assessment from her rival Henry Blodget.


When the Nasdaq (^IXIC) began a steep slide from which, even 12 years on, it has yet to remotely recover, overly rosy analysts made easy scapegoats. Mr. Blodget, who in private emails disparaged as a "piece of s---" one particular tech stock he officially advised the wider world to "Buy," became the poster child for a vocation held in increasingly low esteem.

A Global Settlement enforced by then-New York State Attorney General Eliot Spitzer in April 2003 forced ten big brokerage houses to address widespread conflicts of interest. Industry fines totaling $1.435 billion were imposed, along with a mandate requiring firms to distribute independent third-party analysis in tandem with their own in-house research.

Blodget himself was hit with $4 million in penalties and received a lifetime ban from the securities business. He called himself the profession's "global piñata," although there were plenty other public enemies.

One Citigroup (C) analyst was accused of upgrading AT&T (T) as a quid pro quo to get his twin daughters into nursery school. And a similarly top-ranked researcher found himself fired for telegraphing an upcoming downgrade of Home Depot (HD) to a few select clients. (In this respect, the current Facebook flap is all too familiar.)

The standing of research had fallen so low that a decade ago Fortune felt free to anoint Sallie Krawcheck the "last honest analyst."


The impact of the Global Settlement was most obviously felt in the rise of boutique brokerages, which emphasized their impartiality relative to "bulge bracket" brethren who were beholden to keeping banking clients happy.

Several prominent researchers joined an exodus from larger firms, lamenting onerous additional regulations and sharply reduced salaries. In their place came a generation of younger analysts whose managers showed a fresh willingness to promote from within. Analysts increasingly worked on teams in a departure from the "superstar system" of the late '90s.

Smaller stock picking firms have certainly enjoyed some notable success. In Barron's survey of brokers' "best ideas" portfolios from February, Wall Street giants were noticeably absent from the top honors while Wedbush swept the six month, one year, and three year categories.

McAdams Wright, meanwhile, boasted the best five year performance.

The age-old issue of how to make research pay for itself absent accompanying sales and trading revenue has, however, seen several independent research outfits shut amid declining client dollars.

Still, only last week British-based boutique Autonomous Research managed to capture top ranked money center banks analyst Guy Moszkowski from Bank of America-Merrill Lynch (BAC).

For their part, large research departments still make occasionally unwelcome intrusions onto the front pages -- Goldman Sachs' (GS) ill advised "trading huddles" come to mind - but are no longer in the cross hairs quite as much. In theory, that leaves them free to revert back to more traditional roles of gleaning important insights on a stock and its industry.

Moving Markets

Whatever one's opinion of equity analysts, don't doubt their opinions move markets.

Take two examples from last week alone. Johnson & Johnson (JNJ) surged 2.17% on Wednesday, and gained a Dow (^DJI)-leading 4.8% for the full five days, after JPMorgan's (JPM) Michael Weinstein upgraded its shares for the first time in approximately three and a half years.

By contrast, AK Steel (AKS) slumped 8.3% on the week after getting cut to Sell from Neutral at Goldman Sachs.

The instant reaction of each indicates that the impact of altering research recommendations is often immediate, and fleeting. Indeed a Wall Street Journal article earlier this year asserted "analyst recommendations are like dairy products in that it is best to use them quickly or not at all." After an initial pop or drop, a pronounced period of drift and mean-regression tends to follow.

Wielding the "Ax"

Of the 5,000 or so sell-side analysts, only a select few can be considered an "ax," which is industry parlance for those whose outsize influence impacts companies and even entire sectors.

Gene Munster of Piper Jaffray is widely viewed as the one to watch on Apple Inc. (AAPL). ISI Group's Ed Hyman has been voted Wall Street's top ranked economist for an astonishing 31 straight years by Institutional Investor magazine, a remarkable streak given that practitioners of the dismal science are often said to have been created so as 'to make weather forecasters look good.'

Other researchers have risked ridicule from industry peers and have been cold-shouldered by management at companies they cover for daring to make contrarian calls that, although unpopular at the time, proved prescient.

At the height of the 1999 boom, Mike Mayo advised investors in a 1,000 page publication to sell all bank stocks. He was let go from Credit Suisse the next year and widely viewed as a pariah -- not for nothing was his recent book titled Exile on Wall Street. Nonetheless, heeding Mayo's advice turned out to be the right thing to do at the time.

In the same sector, Meredith Whitney, then at Oppenheimer, warned on October 31, 2007 that Citigroup should be avoided at all costs with its dividend in peril. The opinion initially made her an outcast yet shares, trading above $40 when the contentious call was made, plunged to below $1.00 during the depths of the financial crisis.

Fast forward four years to an equally scary Halloween. When MF Global (MFGLQ) filed for Chapter 11 on October 31, 2011, CLSA's Robert C. Rutschow stood out for having the sole "Sell" among 10 covering the company. (Six said "Hold," a rating often derided as wishy-washy at best, and three advised buying even as bankruptcy struck.)

Ms. Whitney has since founded her own firm and, like Mr. Mayo, ridden a burnished reputation to a book deal, but subsequently struggled to replicate her Citigroup success with a call for massive municipal defaults that have thus far failed to materialize.

Elaine Garzarelli, accorded guru status in an earlier era for "predicting" the crash of 1987, was later fired from Lehman Brothers, and can attest to the extreme difficulty in trying to catch lightening in a bottle twice. (Although, given the fate of her former employer, she can at least claim to have the last laugh.)
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