New York: Sometimes Wall Street seems a bit like the make-believe Lake Wobegon: Most stocks are above average, and it is always a good time to buy.
At least that is the impression you might get from stock analysts who recommend where you should put your money. Even in bad times, Wall Street’s army of analysts rarely shout “sell”. In fact, they rarely utter the S word at all.
But Merrill Lynch and Co. Inc., America’s largest brokerage firm, unveiled a new system on Tuesday for rating stocks that suggests Wall Street finally may be mustering up its courage to say “sell” more often. Starting in June, Merrill will require that its analysts assign “underperform” rating to one out of every five stocks they cover. About 12% fall into that category now.
It’s a tectonic shift for Merrill, the so-called thundering herd whose insignia, a bull, symbolizes the natural exuberance of the market place.
The move underscores an industrywide effort to inject a healthy dose of scepticism into stock research at a volatile and uncertain time for the markets, the broader economy and Wall Street banks themselves. Professional money managers and everyday investors alike are struggling to decide whether the recent rebound in the financial markets—the Standard and Poor’s 500 stock index (S&P 500) is up 10.6% since early March—will fade or turn out to be the start of a broad, sustained recovery.
But researchers are struggling to gain investors’ trust and safeguard their own jobs. Six years ago, big banks paid $1.4 billion (Rs5,936 crore today) to settle claims that analysts hyped stocks to win lucrative banking deals, but researchers as a group still seem reluctant to advise people to do anything, but hold on to stocks or buy more of them.
Today, after the Nasdaq bust and the outbreak of the deepest financial crisis since the Great Depression, only about 5% of all stock recommendations on Wall Street advise investors to sell, according to Bloomberg. That is up from less than 2% back in the heady days of the dot-com boom.
James L. Melcher, a hedge fund manager, said the changes Merrill is making appeared to have “merit”, but he added that they were unlikely to eliminate Wall Street’s tendency to be optimistic or resolve the inherent conflicts of interest in the investment banking business. “I don’t think that is likely to change any more than you would expect human nature to change,” said Melcher, president of Balestra Capital.
Merrill Lynch, not surprisingly, disagrees with that view. Candace Browning, president of Merrill Lynch Global Research, says that her analysts’ work “serves an important function in the capital markets” and that the changes would make investing recommendations from the firm even more useful. “What the new system basically does is it forces analysts to rank their stocks top to bottom,” she said.
The bank analysed stock performance over a decade and determined that from 1997 through 2007, on average 37% of stocks in the MSCI World Index and 40% of stocks in the S&P 500 declined every year. The bank covers about 75% of the stocks in those indices.
Under its new system, analysts cannot assign “buy” ratings to more than 70% of stocks they cover, “neutral” to more than 30% and “underperform” to less than 20%. (An underperform rating suggests the analysts believe the stock will either fall within 12 months or will rise less than competing stocks with higher ratings.)
But some in the financial industry say it may be too late for research departments at Merrill or other investment banks to reclaim the credibility and prestige they lost after the technology stock bust. Hedge funds, which account for up to 75% of trading on some markets, conduct much of their own research and often pay twice the going rate on the Street for analysts. Many banks, by contrast, have cut research budgets.
“If you are part of a mutual fund or hedge fund, you are integral to the business,” said Alan Johnson, managing director at Johnson Associates Inc., a compensation consulting firm based in New York. “On Wall Street, it is not integral; it is just a cost centre.”
Scott Black, who was a Merrill executive in the 1970s and now runs his own investment firm in Boston, said that he was seeing a lot less research from the bank and that analysts were making fewer trips to see institutional clients in places such as Boston.
“All I can tell you is you don’t see things in print and there is a lot less dissemination of research, not that we make as many demands,” said Black, who is president of Delphi Management Inc.
Browning said that Merrill has had “no trouble” recruiting talent, adding that the firm covers more stocks today than it did at the height of the technology boom. She said much of that growth has been fuelled by emerging markets such as Brazil, India and Russia. Today, the company has 750 analysts covering 3,600 stocks, compared with 900 analysts covering 3,500 firms in 1999.
Some analysts say the market does not value investment research about stocks as much as it once did, because hedge funds and other investors are more focused on short-term results than they used to be.
“There’s much more short-term orientation and more emphasis on quarterly earnings reports today,” said William H. Donaldson, a former chairman of the Securities and Exchange Commission and one of the founders of Donaldson, Lufkin and Jenrette Inc., now a part of Credit Suisse Group.
Once an analyst, Scott Cleland, president of Precursor Llc., has stopped producing independent investment research. He now offers consulting services to the communications industry. “The real reason I got out of the business was the market doesn’t care about the future anymore,” he said. “If something isn’t going to occur in this calendar year when institutional investors get paid, it might as well be happening on Pluto.”
©2008/THE NEW YORK TIMES