Monday, October 20, 2008

The Paralysis of the Analyst

Analyst overconfidence is a perennial feature on Wall Street:

According to a recent survey by Thomson Financial, Wall Street analysts are expecting earnings for companies in the Standard & Poor’s 500-stock index to soar 40 percent in the fourth quarter, versus the year-earlier quarter, and 20 percent in 2009, versus 2008. Even more astonishing, those consensus 2009 projections have remained fairly steady in recent months, despite growing fears among investors that a recession is unavoidable.

“Wall Street analysts are notorious for being overly optimistic,” said Christopher N. Orndorff, head of equity strategy at Payden & Rygel, the asset manager based in Los Angeles. “However, the cold, hard reality of disappointing earnings will be with us for some time longer.”

This problem was supposed to have been solved after the dot-com bubble burst, when settlements with regulators forced investment banks to put "Chinese Walls" between their analysts and those bankers prepping road shows. Good luck with that one. Sell-side analysts will always be seen as shills for their bankers.

Fortunately some academics have looked into the age-old problem of analyst mis-estimation of covered companies. Simple honesty and a forced distribution of buys and sells seem to work best. Even Merrill Lynch recently tried to get with the program:

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 percent 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.

Now that many hedge funds are snowballing towards an apocalypse, they'll be laying off a lot of those highly paid analysts. So where does this leave the downtrodden i-bank analyst? Will they regain the esteem they had before dot-bombs and hedgies blew away their bonuses? Most of them will be lucky to have any jobs at all after the Sovereignty Crunch makes Wall Street a much less profitable place.

I'll bet my career that independent sources of analysis (like this blog!) are the future. Bloggers' reliance on ad revenue can keep them free from conflicts of interest. Too bad a lot of unemployed preppies won't catch on to the trend. They're not self-starters and would have to have Daddy Warbucks hire a consultant to explain to them what "initiative" means.