Buy, hold or sell? That is the question, asked in sufficient volumes as to support an entire community of analysts across the globe. But the real question should probably be: “How good are these recommendations to the man in the street?”
To answer this question, we performed a simple simulation. We selected a random set of stocks, 20 with the most bullish analyst calls and 20 with the most bearish, over the past five years (from 2018 to 2022, but excluding 2020). Then for each stock, we picked the point in time (t) when sentiment was the highest (lowest) — using the sentiment bar metric as derived by Bloomberg — and the average target price (TP) at this point. From t, we tracked the individual stock price movements for the next three months. The results are presented in the Table below.
The collective outcome seems to suggest that investors would, in fact, be better off doing the opposite of analyst recommendations! Case in point: For the most bearish calls, prices for 12 (of the 20) stocks were higher at the end of the first and second months (t+1 and t+2) and 13 stocks were up by the end of the third month (t+3). And despite having the most bullish calls, the majority of stocks were trading at lower prices by the end of the first month (t+1) and prices for 16 of the 20 stocks were in the red by the end of the second and third months (t+2 and t+3).
No, this is not an article lamenting the quality of our analysts. Although one has to appreciate the irony, no? And yes, this simulation is not exact science — though we think it was a decent-sized sample, selected at complete random. So, why did we do it then? Well, there is a bit of curious fun, we will admit to that. But there is a fundamental logical reason for these observed results — and on a serious note, some implications for stock market regulators to consider.
As we have said before, the stock market is a market for stocks. And like any other market, prices are driven by marginal demand and supply. When marginal demand exceeds supply, prices rise and vice versa.
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Thus, the actual price movements we see for the stocks above suggest that by the time analysts coalesce to an agreement, and certainly by the time the reports are available to the general public, it is already at the tail end of whatever catalyst is prompting those calls in the first place.
In other words, by the time a “buy report” is issued, the marginal demand is already falling rapidly while marginal supply is rising — hence, prices will trend lower from thereon. Why? Because not all investors are equal. Institutional clients have preferential-selective access to analysts and their research. The biggest, most active and best client will get the first phone call, followed by the second-best client and so on so forth. And by the time the research report gets picked up by news outlets and disseminated to the general public, its informational value is greatly diminished. In fact, the man-in-the-street investors may end up “taking out” those with preferential access (allowing the early investors to sell their positions at a profit). For the retail investors, therefore, here is a valuable lesson and reminder — when something is free (in this case, analyst reports), you are very likely the product.
Time is a critical factor and is inversely related to the value (and profit opportunity) of an analyst recommendation. And therein lies the question for regulators — is this “discriminatory” distribution of information a loose form of insider trading? And if so, how should it be addressed/regulated going forward? Perhaps there is a need to establish some standard operating procedure (SOP) for analyst research activities and the contemporaneous dissemination of information to all — if analyst reports are indeed information that can affect stock prices.
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In fact, we tested this theory recently with our Global Portfolio. Velesto Energy released a dismal set of earnings results after market close on Feb 27. Its share price collapsed from RM0.275 to as low as RM0.18, or nearly 35%, on huge volumes the following day — on the back of a slew of bearish analyst sell reports (see Snapshot on previous page). So, we bought the stock. The shares rebounded to as high as RM0.25 (on March 8), up some 39%, right before the global sell-off triggered by the Silicon Valley Bank crisis.
A critical role for regulators of capital markets is to ensure a fair and efficient capital market, where available information is incorporated into prices of securities quickly, accurately and fairly (that is, no undue advantage to any party). For analyst reports, if they are useful information in price determination, then surely regulators must review how the information is disseminated to ensure it is fair, accurate and not advantageous to any one party (or conversely, not to the disadvantage of the public investors). If, on the other hand, it is deemed “useless” information, then perhaps it is time for analysts to be re-designated as “salespeople”.
Technology — the rise of user-friendly online trading platforms — and accessibility have “democratised” stock trading, by allowing almost anyone with a smartphone to invest easily and economically. And with fractional shares, one can start investing with just small amounts of capital. But as more and more retail investors enter the market — a process that was hastened by the pandemic — regulators the world over would need to review and adjust their rules, as necessary, to ensure a level playing field. Information — and misinformation — can be now be spread almost instantaneously through the internet, and especially via social media platforms.
As their ranks grow, individual investors too are flexing their collective influence. During the height of the pandemic, a group of retail investors — banding together through social media platforms — pulled off a historic short squeeze on institutional investors, inflicting heavy losses on the latter. That said, those who bought at the peak of the frenzy would also have suffered substantial losses at today’s prices, muddying the risks and benefits — and prompting regulators to scrutinise if and how social media platforms could be better regulated to enhance investor protection.
More robust guard rails are needed to protect retail investors, especially the younger generation, and make sure they are not burnt and thus, deterred from investing, which remains one of the best ways to improve financial literacy and build wealth over the longer term.
Case in point: The US Securities and Exchange Commission (SEC) recently proposed a revamp to how Wall Street handles retail stock trades, where rules have long been stacked against Main Street investors, in Wall Street’s favour. Currently, wholesale market makers are allowed to pay brokers for retail orders — and execute the trades internally (off-exchange) instead of opening them to order-by-order competition. This practice is very lucrative for brokers and market makers, and controversial with regulators, as it could lead to suboptimal execution prices. As we said, when something is free (zero commission trading), you are the product.
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The SEC’s proposed plans include requiring retail stock orders be sent to open and transparent auctions, so that trading firms will have to compete directly — thus, providing the best possible prices for investors — as well as new procedural standards for brokers to demonstrate they have gotten the best execution for these transactions. (For those interested in reading more on this, scan the QR code below for the SEC’s press release and the proposed rule to enhance competition for the execution of marketable orders of individual investors.) The bottom line is, regulators need to address and adapt to emerging risks and concerns as the democratisation of the financial markets continues to evolve rapidly.
The Global Portfolio finished flattish for the week ended March 22. The big gainers were DBS Group Holdings (+3%), Oversea-Chinese Banking Corp (+2.1%) and ABF Singapore Bond Index Fund (+1.9%) while Grab Holdings (-2.5%) was the only loser last week. We disposed of our shares in Velesto for a gain of 6.9% and pared our holdings slightly in the iShares 20+ Year Treasury Bond ETF. After the disposals, cash increased to 20.6% of total portfolio value. We intend to raise our cash holdings further overt he coming weeks. A recession now appears inevitable, and a liquidity crunch a possibility. The math is, there is US$18 trillion in deposits in the banking system and US$125 billion in deposit insurance funds. As we said, cash will be king. Total portfolio returns since inception now stand at 22%, trailing the MSCI World Net Return Index’s 39.5% returns over the same period.
Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/ or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.
