The Market Movers
Tom Kurlak cannot leap tall
buildings in a single bound, but he can single-handedly make stock prices rise
or fall. Micron, Intel, Texas Instruments--Kurlak has brought them all down and
picked them all up in the past year. Every time he issues a public statement,
in fact, the market moves. The reason is simple: Kurlak is the most important
sell-side analyst in the semiconductor industry at a time when analysts have
become perhaps the most important people on Wall Street.
"Wednesday's selloff began
when Merrill Lynch analyst Tom Kurlak downgraded his earnings estimates for
Micron." "Merrill analyst Tom Kurlak told investors in a conference call that
he expects Intel's third-quarter earnings to come in below an earlier Merrill
Lynch estimate of 92 cents. That sent shares of the world's largest chipmaker
tumbling 3 1/16." "Micron Technology Inc. jumped 4-3/8 Tuesday on positive
comments from Merrill Lynch analyst Tom Kurlak." These quotes are from just the
past three months. Go back further and you can collect many more, all
reflecting the same strange fact: Kurlak changes his mind all the time, but
every time he changes it the market responds.
In and of
itself, this might seem just an odd--perhaps cultlike--phenomenon. But Kurlak
is no kook. He has been at the job for well over a decade and has been an
Institutional
Investor First Team All America analyst--no
kidding--five different times. Kurlak is simply an extreme example of Wall
Street's new reality, which is that no one has as much influence as the people
who supposedly know where a company's stock price is going to go.
Securities analysts were relatively unimportant on Wall
Street before the 1960s, but their rise to power has not been sudden. As early
as 1977, when the stock market wallowed in the doldrums, Wall Street chronicler
Robert Sobel observed that a successful analyst could "become something of a
celebrity, called by New York Times and Wall Street Journal
reporters ... invited to seminars in resort areas, and asked to submit articles
to trade and related publications." By 1984, when the bull market was just
beginning, analysts were being called "minigods"; and by the late 1980s, top
analysts were pulling down salaries in the high six figures, although they were
still a long way from the Masters of the Universe terrain then reserved for
bond traders and deal makers.
Over the past few years,
though, the dramatic upsurge in money pouring into the market and the resultant
pressure on institutional investors to improve their performance have sharply
increased the value of anyone with a clue about what's going to happen to the
pharmaceutical industry--or to chemicals, or to semiconductors. At the same
time, growth in the market for financial news has made analysts public figures.
Daily newswires are filled with announcements of upgrades and downgrades from
brokerage houses, while market-wrap articles often cite analysts' reports not
as commentary but as news in their own right.
Finally,
and perhaps most importantly, the sharp expansion in the market for initial
public offerings and secondary stock offerings has made it essential that
brokerage houses have analysts who are well respected in their field.
Corporations, sensibly enough, do not want their stock offerings underwritten
by houses whose recommendations will carry little weight with investors.
In 1996, Wall Street firms took home nearly $3
billion from underwriting IPOs, which means that winning or losing two or three
big deals can be the difference between a great year and a bad one. And that
has meant that analysts are now often valued as much for their rainmaking
abilities as for their predictive expertise. Top analysts now spend far more
time on the road, trying to drum up business, while much more of the actual
analytical work is being done by junior analysts back at the office. Not
surprisingly, since analysts are now crucial figures in the underwriting
business, their compensation has tripled over the last three or four years.
According to Institutional Investor , top analysts who follow hot sectors
make well over $1 million a year, while most senior analysts bring home more
than half a million dollars. Though analysts are still not as highly paid as
investment bankers, the gap is much narrower than it was in the early
1990s.
As a
result, the vaunted Chinese Wall between the underwriting and research
departments of Wall Street houses has become a fiction. While there's no
evidence that direct pressure is brought to bear on analysts to paint rosy
pictures of a company's prospects, corporations expect what's called
"after-market support" from their underwriters. This is a polite way of saying
that they don't want to be hung out to dry by a "neutral" or "sell"
recommendation two months after they go public.
Some conflict has always been inherent in the analyst's
role. Houses that are bearish are not houses that get a lot of underwriting
business. And issuing a "sell" recommendation has a way of making a company's
management unfriendly, which in turn may limit an analyst's access to
information in the future. It's perhaps not surprising, then, that a recent
study showed that analysts issue "buy" recommendations seven times as often as
"sell" recommendations.
We are, of
course, in a bull market, which means that analysts should have been
recommending that clients buy more often than they sell. Even so, analysts'
recommendations have manifested the Wall Street equivalent of grade inflation.
"Neutral" is generally understood to mean "sell," "outperform" to mean "your
call," and "accumulate" to mean "you might want to buy it if you have extra
money lying around." I think "buy" still means "buy," but then some houses use
"strong buy," so who knows?
This has had paradoxical consequences. Even as
analysts have become more able to move stock prices, their more
corporate-congenial language has probably diminished the long-range
impact of their recommendations--with so many "outperforms" and "accumulates"
out there, it's hard to know which ones to take seriously. In the short
term , however, the effect has been to increase price volatility, especially
when analysts issue "strong buy" or "sell" recommendations. Knowing that
analysts can now move the market, speculators jump in and out. When Kurlak cuts
his rating on Intel, what matters is not that he's right or wrong about Intel's
prospects but that his cut in the rating will drop the stock regardless.
Why should this concern
anyone outside Wall Street? The first reason is that analysts are essentially
unaccountable for their recommendations. No one says: "We can't quote this guy.
He's been wrong four out of five times on this stock." So their ability to move
stock prices--which, in theory, encourage efficient capital allocation--is
troubling. The second, more important answer is that analysts are crucial
contributors to short-term thinking. Their issuing of "short-term buy" or
"short-term hold" recommendations obviously intensifies pressure on companies
to meet and beat earnings expectations at all costs. When you couple that
reality with an overly narrow definition of "shareholder value," you end up
with a corporate world that must privilege the next quarter over the next
decade. Which somehow doesn't seem to be the best way to prepare for the next
decade.
