Analyzing analysts

Nowadays on the television money channel throughout the day a prominent financial analyst appears. Usually that individual is affiliated with a bank or investment dealer. This person presumably will provide a knowledgeable opinion on the economy, the outlook for coming months, or a commentary about suitable investments.

In the late 1980s, some of those talking heads became celebrities, and investors seemed to hang on their every word. Heretofore, before these personalities emerged, analysts were employed for the relatively serious task of reviewing economic trends and current news of various companies. Their research was used internally to trade in the dealer’s account, and eventually to be distributed to favoured clients. The purpose, of course, was to get clients to work with the dealer; to appreciate that research was a serious activity.

A few of those analysts became famous stars, and because they developed a following, for some time their predictions became self-fulfilling. People invested according to the predictions of an eminent analyst.

At the top of the heap was Alan Greenspan, the head of the U.S. Federal Reserve System, its central bank. If he made an upbeat comment, the market rose accordingly. His verbose and complex utterances so often set the tone of the market. All that came crashing down when his words in 2005 on the United States’ housing market rank high on history’s list of infamous predictions. He then said it was highly unlikely that average home prices would drop, arguing that only happened during a deep depression like the 1930s. Unfortunately, new information reveals that house prices already have fallen by more over the past 12 months than in any year during the Great Depression.

Over the past few decades analysts were expected to build profiles for the firm and themselves: economics and the world of money became part of everyday life. What they said seemed to be less important; it was only vital that they were seen and constantly in the public domain. One economist-analyst asked in a moment of candour whether or not he should join the entertainment trade union.

It is not surprising then that the quality of research took second place and declined while the number of analysts increased. Often the research was agonizingly detailed but proved to be of doubtful relevance.

One analyst threatened to down­grade his employer and a company under review unless he was judged and then voted as "outstanding" in a poll conducted by a financial journal.

An academic examined the performance of analysts, concluding that generally their popularity did not tie up with the accuracy of their predictions. They were influential but not really helpful, more amusing than anything else.

Clearly, not all analysts should be tarred with the same brush; however all should be viewed with extreme caution.

 

Bruce Whitestone

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