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‘Sell’ preservation society – A lack of analyst ‘sells’ is one more reason to do your own research

17/07/2015

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

In some ways you have to admire their upbeat attitude. The rest of the investment world may have spent recent months fretting over such concerns as the possibility of Greece leaving the eurozone, the Chinese market bubble and the unstable geopolitical situation – and yet company analysts are apparently now more bullish than they have ever been.

So at least says this Financial Times article, quoting an index calculated by Bloomberg that ranks analysts’ recommendations on a scale of 1 (a strong ‘sell’) to 5 (a strong ‘buy’) and currently has the median call on US stocks standing at a record 3.85 – some way ahead of the dotcom high of 3.73 and the pre-financial crisis peak of 3.74.

Given how, as we noted in Curious consensus, the average consensus rating on all European stocks has actually been at a 25-year low, we might reasonably assume it is not standard practice for brokerage houses to keep their analysts locked in the basement and away from all newspapers and other media – so just what is going on here?

Perhaps analysts are just a more optimistic tribe – certainly a view we have expressed more than once here on The Value Perspective – but the FT raises some other possibilities. The first of these is what it calls “extrapolative expectations” and what we might describe as the not uncommon belief among some investors that, if a share price is heading upwards, it can only continue heading upwards.

More worryingly, however, the article suggests the “slow death” of the ‘sell’ recommendation could be a symptom of a deeper structural change, elaborating: “Equity research teams are clinging to ‘buys’ and ‘holds’ because they do not want to upset colleagues in other parts of the bank.” After all, as it notes, commissions from trading stocks are falling, due to thin volumes and greater competition.

“At the same time, with profits squeezed by low interest rates and regulatory penalties, banks are trying to maximise revenues by selling as many services as possible to their most active clients,” the article continues, before concluding: “So why risk offending a chief executive by slapping a ‘sell’ rating with the bank’s name on it?”

One possible answer to that question might be found in the $1.4bn (£900m) in fines some of the US’s largest banks had to pay up when the US regulator identified conflicts of interest between their investment banking and research arms after the dotcom bubble had burst. Mind you, that was more than a decade ago now, which for some people in the investment world may as well be a millennium.

Here on The Value Perspective, we would imagine investment banks will have strengthened the Chinese walls between their various departments, just as regulators will have intended. But then again, with those regulators now having turned their attention to just how equity research is paid for, we can equally imagine a less profitable part of a business being less inclined to upset more profitable areas.

As the FT article concedes, “it is hard to say for sure that cross-selling pressure has had a bearing on analysts’ ratings” – although it quickly follows that line up by noting “of the 18 ‘sells’ among 364 recommendations on the 10 biggest stocks on the S&P 500, just five come from this year’s top 10 managers of equity offerings”.

Whatever the realities of the situation may be, here on The Value Perspective we will not be changing our long-held stance that, when it comes to analysing businesses, there is no substitute for doing your own work and the only opinions we are prepared to rely on 100% are our own.

Author

Nick Kirrage

Nick Kirrage

Fund Manager, Equity Value

I joined Schroders in 2001, initially working as part of the Pan European research team providing insight and analysis on a broad range of sectors from Transport and Aerospace to Mining and Chemicals. In 2006, Kevin Murphy and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Kevin and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.

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