Reflecting on the precipitous and historic drop in our markets Thursday, May 6th (conjectures aplenty; cause yet unknown, but I was there!), I am reminded once more of the negative role played by one market participant—the analyst. (Of course there are other issues, such as executives with generous compensation packages regardless of performance, but my focus is on analysts in this article.)
First, why should YOU care?
If you have a pension plan, 401K, IRA, mutual fund, or like me, invest in stocks and options, the future you’re working hard for may be at risk. As a caregiver your hands are already full as you try to juggle a semblance of life balance. Many of you leave it to the “experts” to ensure your investments make a reasonable profit.
Take a few moments to read the rest of this article as parts of it will surely open your eyes. Then be sure to post a comment.
Analyst estimates and expectations are a hindrance to market forces.
The way it should work.
Analysts pore over data, SEC filings, and sit in on quarterly earnings reports. Some even visit the companies they’re following to see the operations first hand, and to interview employees and senior management. This is the Warren Buffett method.
The way it appears to work, today.
Analysts review company data, talk with other analysts, look at sector performance, and some “attend” quarterly earnings calls via cell phone during rush-hour traffic, asking questions that prove they’re not really listening. (I know, I sit through these calls!) After tracking the stock movement of 50 companies and researching more closely about 15, I’m beginning to wonder if there’s a nugget of truth to my nagging thought that an analyst may easily work a deal with a fellow analyst at another company.
I’ll scratch your back if you scratch mine.
This is how I see the “I’ll-scratch-your-back,-if-you-scratch-my-back” deal unfold.
Analyst A and B, each from different companies get together for lunch. They start talking about two companies. Analyst A might “suggest” that s/he plans to upgrade Company ABC, a company Analyst B follows. In return, Analyst B “hints” that s/he plans to place a hold rating (in effect a downgrade) on Company XYZ, a company Analyst A’s company wants to trade short. The deal’s done. Each does as promised and the companies’ stocks move according to plan–if not that day (people are growing increasingly wary of analysts), then within the next few days.
Is this ethical? Heck NO! Can the SEC prove it? Not really. As it is, we don’t have enough resources to monitor or investigate all the regulations we have now.
Using this technique (and others that have yet to come to light), Analyst A’s company’s hedge (short sale) benefits from Analyst B’s hold rating, while B’s company profits from A’s upgrade of Company ABC.
Again, how could the SEC possibly trace an innocent conversation between two analysts over a round of golf, drinks at the corner pub, or a social?
The Dance between Corporations and Analysts
After a company reports quarterly sequential earnings growth, it’s stock price should rise. Today, JC Penney reported their first quarter earnings more than doubled. Yet the stock dropped. Why? Penney’s earnings met analysts’ expectations and executives at Penney are taking a more cautious view of the rest of the year.
Company executives are getting smart to the game. Dragged onto the dance floor, these days, they begin with the dance steps to Lowered guidance for the rest of the year. Analysts take the lead and lower their estimates, which the company easily surpasses. This exceeds analysts’ expectations which raises the stock price. Companies and analysts do a limited number of these dances before they choreograph a new dance routine.
Games that detract from real economic growth
Aren’t these just games that distract from the true nature of business and real economic growth?
Surely, this increases market volatility, which is great for short-term traders. However, and more importantly, this weakens the integrity of our markets and pulls us farther away from fundamentals.
As it is, despite the plethora of plentiful information available to the individual retail investor, investors and traders are increasingly finding it difficult to figure out today’s markets.
Eventually, more and more people will be disgusted and we’ll see some major policy shifts.
WAIT! That’s happening now!
Cause of the crash last Thursday…a few of the daily headlines:
- Unidentified trader enters B for billion instead of M for million.
- Wall Street plummets on Euro debt and Greek austerity (spending reduction) measures
- NYSE walks away from the market. NASDAQ and other electronic trading boards cause crash
- Program trades (78% of the market trades this way) cause historic slide in markets
- High frequency traders (60% of the market activity in the US)
- Market makers provide .01 cent price liquidity
- And today’s top breaking news…
- A futures trader at Waddell and Reed sold 75,000 e-mini contracts hedging the S&P Index–a legitimate hedge trade that acted to escalate the fall
The SEC is investigating. This will take a long time. We will hear more causes; but the market will eventually recover. Seeing the value of our portfolios rise, we’ll soon forget about these issues. After all, how can we even be sure these are legitimate causes and not some stories crafted by companies to distract the media?
I welcome your comments.
Brenda Avadian, MA
Caretaker to The American Dream
Founder & Editor of TADWU.us and TheCaregiversVoice.com