When analysts speak, people listen - but it's others who profit
12:00 AM CST on Monday, November 9, 2009
Equity analysts at the large brokerage firms and investment banks are constantly issuing upgrades and downgrades on stocks as if someone actually cares.
I mean, are there investors out there who actually buy and sell stock based on these recommendations?
Often these reports seem to state the obvious – such as putting a sell rating on Citigroup Inc. when it's all but insolvent or putting a buy rating on Google Inc. after it has already doubled in price.
Also, the vast majority of these research reports are mostly positive, because many analysts seem to walk in lockstep with the companies they cover.
Well, I have been given a little more insight into this topic by one very savvy former Wall Street analyst, who now teaches finance at The University of Texas. Professor Jennifer Juergens and a co-author, professor Laura Lindsey of Arizona State University, have brought some heavy-duty cognitive labor to the topic and published it in the latest edition of the prestigious Journal of Finance.
What they discovered was that trading volumes dramatically increase at the firms on the days analysts issue upgrades or downgrades. That translates into gobs of trading commission revenue for the firms.
Now I get it. Analysts are making some serious scratch for their firms by pounding out these reports, so someone must actually be paying attention.
Juergens and Lindsey examined the trading records at some 220 firms and found daily trading volume increased an average of 59 percent on the release day of downgrade recommendations and 70 percent on the release day of upgrades.
"The economic magnitude of this is big," Juergens said in a recent interview. "It could be as large as $1 billion a year."
But here's the dirty little secret (my word, not Juergens'): The data she and Lindsey gathered strongly suggests that "some investors have access to information contained in analyst reports in the days prior to the official release."
Bingo! Some of the clients at these firms aren't being served stale bologna sandwiches. No, they are getting hot-off-the-grill fillets, otherwise known as a pre-release of analyst recommendations.
Juergens said they weren't able to determine who is doing the advance trading at these firms, but their evidence suggests it is happening.
"We don't know if it is the institutional clients of the firm. We don't know if it is the retail clients. We don't know if it is the firm's proprietary desk," she said.
The proprietary desk refers to the firm's in-house trading operations. She did say, however, that there is more of this kind of activity occurring at firms with proprietary trading operations. In other words, it could be that the analysts are passing along their research to their own traders.
Now if all this sounds rather tawdry, if not outright illegal, I will agree with you on the former but not the latter. Analysts don't have to release information to the entire market at the same time, otherwise there would be no benefit of being a client of, say, Goldman Sachs or Morgan Stanley.
Also, it's not insider trading because analysts are not insiders of a public company. And besides, they're just issuing opinions.
However, the Financial Industry Regulatory Authority does have a revised rule requiring that firms establish policies to restrict information flow between analysts and the trading department.
Juergens isn't overly impressed with the rule.
"A lot of firms we looked at did have policies in place," she said. "It is just not clear that they are enforcing them. The behavior will probably continue to exist."
And that's a shame, because the objective of these rules is to promote a level playing field for all market participants.
dallasnews.com
(post copied from another board) |
