BEING STREET SMART
by Sy Harding
Wall Street's Self-Serving Advice! (August, 2001)
In a chapter titled "Public Investors Versus Wall Street" in Riding the Bear I warned that Wall Street spokespersons who make repeated appearances on financial TV and radio shows, and make themselves available for lengthy newspaper and magazine interviews, do not take all that valuable time from their jobs and responsibilities out of the kindness of their hearts, or a desire to help complete strangers (from whom they receive no compensation) get rich. They do so to further their own agenda of promoting stocks for their brokerage firms, or in the case of money managers and mutual fund executives, to bring more public buying into stocks they already have in their portfolios, to produce higher prices for their own profits, or even to suck in enough buyers to take the other side of their trades so they can unload the stock.
It was hard to convince investors when the market was in the strongest bull market in history and big profits were being made anyway, that following the free advice was dangerous. But with the huge losses that investors have suffered over the last year and half, the truth is slowly coming out.
Even the Securities & Exchange Commission is finally getting on the bandwagon. It issued an "investor alert" in June cautioning investors to be wary of Wall Street analysts' free advice for buying or selling stocks. It warns that investors need "to understand the potential conflict of interest that analysts have," and goes on to warn that analysts might use positive-sounding reports and buy recommendations to help support shares that the analyst's brokerage house helped bring public. Or the analyst could be issuing favorable reports to boost one company's stock in order to lure other companies into investment-banking relationships with the firm. The SEC even points out that (gasp) at some firms analysts' pay is significantly affected by how much the analyst is able to help the firm's much more lucrative investment banking business [even at the expense of the company's brokerage business customers].
Some sections of the media are finally being more courageous than others in reporting the situation, taking chances of losing considerable advertising revenue from Wall Street firms by telling the truth. Even in those cases it's too bad they couldn't have found their courage a couple of years ago when the warnings could have prevented millions of investors from being sucked into the bubble by some of the obviously ludicrous 'stories' Wall Street was broadcasting about the internet and high-tech sectors. However, better late than never;
A couple of months ago, Fortune magazine ran a cover story "Will Investors Ever Trust Wall Street Again?" a rundown of the antics of Morgan Stanley Dean Witter's Mary Meeker, who gained fame as an expert analyst on the Internet sector.
Individual Investor magazine recently ran an article titled "Hall of Shame", pointing out just how badly investors were misled by those few analysts who became actual celebrities thanks to their many appearances on TV.
Mary Meeker topped its list. To quote from the article: "More than most analysts Meeker was heavily involved in the investment-banking side of her firm, helping Morgan Stanley Dean Witter to take new Internet start-ups public. When these stocks began trading, she then hyped them in reports to the firm's sales force. She became identified with the rise of the dot-com culture because of the enormous influence she could bring to bear, both in raising capital on the investment banking side, and then affecting stock prices on the sales side."
As we all know, when Meeker appeared on CNBC to talk about a few Internet stocks, with the ridiculous claims that lack of earnings or a viable business plan didn't matter because the Net companies were 'building critical mass', those stocks would soar 20% or more in a day on heavy volume.
The New York Times noted last December that Meeker maintained an outperform rating on all of her Internet stocks all the way down as they lost an average of 83%, and still will not disappoint her investment banking clients by conceding in public that the stocks were disasters.
Second on Individual Investors' 'Hall of Shame' list: Henry Blodget, who became famous when at CIBC Oppenheimer he predicted that Amazon.com (then trading at 200), would hit 400 within a year. CNBC-TV picked up on the prediction, just the kind of stuff they love, and gave it high-profile coverage and commentary for more than a week. Sure enough, with that additional promotion the stock reached 400 not in 12 months but in just 3 weeks. Blodget's reputation for 'knowing' the Internet stocks was established. Merrill Lynch hired him, and he began pushing other no-profit, no business-plan Internet companies, twisting facts inside out to justify ridiculous valuations. He had to know they were bizarre. He's not stupid. Just a few of his "undervalued" recommendations besides Amazon, now selling at 12, there was VerticalNet. In March, 2000 he predicted a target of 350 in 12 months. It's now selling at 2. In February, 2000 Merrill Lynch took Pets.com public at 11, and Blodget predicted it would hit 16 in 12 months. By November it was out of business.
The New York Times jumped on the new "Truth about Wall Street" fad, a tad late but better late than never. It published a front page story describing how Blodget continued to recommend Internet stocks all the way down in their horrendous plunge. The Wall Street Digest says, "Merrill Lynch paid Blodget millions to hype stocks that benefited the investment-banking side of their business. Brokerage clients of Merrill Lynch are furious. They listened to Blodget and lost millions buying stocks of companies with no earnings. How many of Blodget's recommended companies are now out of business? Merrill Lynch doesn't want you to know. But 500 dot-com companies have closed their doors completely."
The third name on Individual Investors' Hall of Shame list is Dan Niles. Of all analysts he was the most inexplicably bullish on semi-conductors, claiming these always cyclical stocks, would no longer be, and would thrive even in an economic slowdown. Brokerage firms have been trying to bring buying back into the chip stocks since the bottom fell out for them over a year ago. Last week, Merrill Lynch was again able to get a brief but exciting rally going for them by predicting for the third or fourth time since the carnage began that the bottom was in for the semi-conductor sector. (Yesterday CS First Boston downgraded the sector, warning there's no end to the decline yet in sight, and even when the inventory hang-over of chips gets worked off it will be as long as two years before the tech sector reaches the stage of needing large amounts of chips again).
The fourth name on the Hall of Shame list is Jack Grubman, who The Wall Street Digest, also commenting on the Hall of Shame list says, "openly wears two hats - as an investment banker at Salomon Smith Barney as well as a stock analyst for the brokers on the sales side. His specialty was hyping the telecom sector. His entire telecom group - Worldcom, Global Crossing, PSINet, Rogers Wireless, ICG Communications - eventually blew up; but he didn't downgrade anything until it had fallen 70% or so."
Are the patterns of hyping stocks mindlessly the result of decisions by individual analysts, or part of the business plan of their employers and Wall Street in general?
The Investors Business Daily of March 22 carried a story from which the following is quoted; "J.P. Morgan's Peter Houghton, told his analysts in a memo that they must clear stock recommendations with corporate clients and investment bankers at J.P. Morgan."
Is it any wonder then that, as First Call reports, only 1% of 28,000 stock recommendations in the year 2000 were recommendations to sell, even as the Nasdaq plunged more than 50%?
Financial TV shows have tried to give an appearance that they're involved in a fix of the situation by instituting rules that money managers and analysts appearing on their shows to hype stocks must reveal whether or not they own the stocks. Any viewers thinking that is any help are so caught up in the hype they must be delusional.
Congress to the rescue? Congress has appointed a subcommittee to hold hearings to look into how Wall Street analysts operate. As mentioned at the top of this commentary, the SEC is issuing "investor alerts" warning investors to understand the conflicts of interest that analysts have, as a stop-gap while they try to come up with a fix. But don't get your hopes up.
As pointed out in Riding the Bear, there were investigations, new regulations, and promises of reform by Wall Street after every previous raping of investors. But new methods and loopholes have always managed to emerge. Each time regulators allow the new scam methods to continue until the damage is done, and afterwards exclaim amazement that it was going on. For instance, we were the only ones that knew what Wall Street spokesmen and the media were doing in artificially boosting stock prices? Of course not. We may have been the only ones to write and warn about it in Riding the Bear and the Street Smart Report, two years ago but everyone in the financial media and the securities industry knew what was happening.
Some examples of the full blown investigations and media 'revelations' after previous scandals had taken their toll on investors were described in Riding the Bear, including the rush to investigate after the biggest stock market disaster ever, the 1929-32 bear market. Congressional investigations dominated the headlines, the first ever regulations were imposed, the Securities & Exchange Commission was established (with admitted stock market manipulator Joseph P. Kennedy as its first Chairman) to police the securities industry. But not much changed thereafter. New methods of scamming were soon developed.
After the 1987 crash, Congressional investigations determined that program trading associated with the strategy of "portfolio insurance" had caused what should have been just a well-mannered and normal market correction to accelerate into a crash. So restrictions on program trading were imposed, including 'collars' that limited program trading any time the market moved a certain amount within a day. Has it worked to limit program trading, or cause it to be so ineffective that it faded away? Not hardly. As we have warned a number of times, program trading now accounts for an amazing 26% of total trading volume on the NYSE, with an additional substantial amount taking place off the floor.
The resulting market volatility of recent years has been duly noted in the financial media, but no one mentions the source of much of the volatility. But the market, as measured by the Dow and Nasdaq, is roiled several hundred points in both directions within the same day several days a week, as the program trading firms switch back and forth between their huge buy and sell programs for small but fast profits. By the way, the program trading firms are the large, well-known brokerage firms, trading for their own accounts and those of their largest customers. When the trading collars were instituted after the 1987 crash, I commented that investors would eventually learn that whether the damage was done in a one-day crash or forced by the 'collars' into a series of smaller moves, the result of program-trading's massive influence would be the same. I believe that has come to be the case.
While we're on the subject of the kind of analysis and recommendations investors are receiving when they pay attention to the steady stream of Wall Street spokesmen, mutual fund, and money managers, etc., on CNBC, CNNfn, Bloomberg TV, etc., according to Investars.com, since 1997, a four year period, following all the recommendations by brokerage firm analysts where the firm had assisted in the IPO would have created losses averaging 51%.
Given the super-star status now being accorded by the media to analyst James Cramer, co-founder of theStreet.com, (the no-earnings internet company whose stock was promoted up to 25, only to rapidly plunge to 1 1/4), and hedge-fund manager who decided to 'retire' from his hedge fund in December, commentary by Alan Newman in a recent issue of Crosscurrents is interesting:
"We feel obliged to point out the outrageously wrong forecasts of analyst Jim Cramer. At the 5th Annual Internet and Electronic Commerce Conference in New York on February 29, 2000, Cramer said, "You want my top 10 stocks for who is going to make it in the new world?" Cramer then insisted on listing the entire group as if offering the rarest gems. The list included Ariba, Digital Island, Exodus Communications, Infospace, Inktomi, Mercury Interactive, Verisign, and Veritas. Cramer concluded by claiming he loved his list so much he would rather not own any other stocks. Just eight trading days later the Nasdaq peaked and crashed. Ariba, Infosapce, Digital Island, and Exodus are down more than 90%. The best performer in Cramer's list, Mercury Interactive, has lost 'only' 38%."
Newman goes on to say proof that the mania has not yet reached its final end can be seen in the way that Cramer is still listened to. In fact, CNBC hired Cramer upon his 'retirement' from actively managing people's money, to provide investment advice to its viewers in prominent formats and round table discussions. Do they even try to get the best people to provide advice and commentary, or just look for 'personalities' and media showmen who can put on the most exciting 'show' for viewers.
It's interesting that on February 29, 2000 when Cramer was expounding at the Internet and Electronics Conference in NY on the exciting future for Nasdaq stocks, my article warning that the Nasdaq was about to crash to its 200-day m.a., and that we advised selling the Nasdaq short, was being edited for its publication in the March 6, 2000 issue of Barron's. The Nasdaq's plunge began just 3 trading days later.
It is advisable to look on free advice provided by Wall Street and the media with a healthy dose of skepticism, asking "Why are they being so good to me, providing such valuable advice free?"