Hats Off To Sell-Side Analysts Who Have The Courage To Be Bearish6 November, 2011, 2:12. Posted by Zarathustra
Tags: Mike Mayo
Sell-side analysts’ job is to generate ideas for their clients, mostly institutional investors, so that they would trade with the banks and the banks can generate revenue from those trades. Thus the truth is that the incentives for them to generate ideas that sell is probably going to be greater than to generate ideas that are right.
Thus most of the time, it is actually harder for analysts to be bearish. After all, all investors can buy stocks regardless of whether they have owned it or not, but only investors who have those stocks already can sell, unless you are a hedgie. Bearish views seem to be invariably less popular than bullish views, perhaps because human being is naturally optimistic (?), so that the consensus is more often positive than negative. Being bearish is often a lone voice, so it seems.
Mike Mayo of CLSA, who has criticised US banks for a number of years, wrote a book which is recently out, called Exile on Wall Street: One Analyst’s Fight to Save the Big Banks from Themselves. Wall Street Journal published an excerpt of it, which says:
Analysts are supposed to be a check on the financial system—people who can wade through a company’s financials and tell investors what’s really going on. There are about 5,000 so-called sell-side analysts, about 5% of whom track the financial sector, serving as watchdogs over U.S. companies with combined market value of more than $15 trillion.
Unfortunately, some are little more than cheerleaders—afraid of rocking the boat at their firms, afraid of alienating the companies they cover and drawing the wrath of their superiors. The proportion of sell ratings on Wall Street remains under 5%, even today, despite the fact that any first-year MBA student can tell you that 95% of the stocks cannot be winners.
To complement that, I would recommend and excellent post here on sell-side over-optimism, which says some, I would say, sad truth about analysts who are more interested in getting their calls right:
It follows then that the career risks in being bearish and wrong far outweigh the benefits of being bearish and correct. The experience of Quant Strategist Richard Bernstein while at Merrill Lynch in the 1990s is instructive here, illustrating the importance of timing. (For the record, Bernstein is my pick as the best strategist alive, but thats a story for another day). In 1997, Bernstein stridently made the case that technology stocks were drastically overvalued, in a bubble, and poised to fall more than 50%. The trading floor and investment banking departments were understandably displeased that their strategist dared to step in front of the money train, and struggled to explain away the conclusions while the steady conveyor belt of .com new issues (the true high margin cash cow of the industry) remained 400% oversubscribed.
By mid 1999 there were rumors that Merrill would replace Bernstein with a more malleable Abby Joseph Cohen “buy at any price” clone. Ms Cohen had assisted Goldman in generating steadily higher market share in tech stock trading and underwriting with a relentlessly bullish, “tree will grow to the sky” outlook for the industry. This outlook, supported by 60-slide presentations outlining future growth, helped portfolio managers assuage their anxiety over insane valuation levels and allocate more of the oceans of client funds coming through the door into the most overpriced market darlings of the day – Cisco, Intel, Oracle, Amazon, Yahoo!, Microsoft and the whole host of hot money hangers on. The 8:00 calls from Goldman institutional sales people were much easier and more profitable to make than for their counterparts at Merrill (although admittedly Blodgett helped offset the difficulties). Ms Cohen was made partner just as the implosion began, again, not because of prescience but because of successful, commission-generating cheerleading.
So, hats off to those sell-side analyst who have the courage to be bearish while most others aren’t bearish, because that’s mentally exhausting.