Positivity Sells, Does Pessimism?

Last week I shared one of Wall Street’s tricks. Specifically, how returns are calculated. My purpose was for you to understand chained returns versus arithmetic returns. Today, I’d like to share another “sleight of hand” so-to-speak. This one concerns the frequency of buy and sell recommendations as it relates to the Wall Street machine.

In 2000, Fortune magazine ran an article titled, “The Top Picks From Wall Street.” The gist of its findings was that Wall Street analysts issue many more buy recommendations than sell recommendations. “Analysts made 33,169 stock recommendations the prior year. Of those, only 125 were recommendations that you sell that stock or approximately .34 percent (1 in 300).”

Fortune isn’t alone here. Many publications and studies offer the same result for a multitude of reasons. For example, if Fidelity Investments places a buy rating on your favorite company, it may not be because it thinks it will go up in price. It could be for another reason.

Most investors don’t know that many of the financial firms that issue buy ratings also do other business with the companies being rated. Think about it. If you’re an investment bank, It’s not wise to issue a sell rating (thus causing a stock price to fall) in one breath and ask for advisory or banking business with the next! (Follow the money!)

From one of my favorite books - The Capitalist’s Lament:

“Despite how things turn out, there is a tremendous bias towards optimism. Wall Street insiders will not offer advice that will adversely affect their own incomes, and their customers don’t want to hear bad news. Who’s going to buy stocks and other securities after being told that values will decline?”

Some Latin may help here. Caveat Emptor – let the buyer beware.

That’s just the way it works!