From the May 01, 2008 issue of Futures Magazine • Subscribe!

Full of Bull: Do What Wall Street Does, Not What it Says, To Make Money in the Market

By Stephen T. McClellan

October 2007

222 pages, $22.99

This book is not a soft-focus memoir. McClellan charges hard. He cites two main reasons why investors should treat Wall Street research skeptically. First, securities analysts do not bill clients for service; they draw compensation from at-large company revenues and face pressure not to alienate clients by downgrading opinions. The second reason for skepticism is that Institutional money managers provide most of Wall Street’s brokerage revenues and they are not happy when a securities analyst cuts the rating on a stock they hold. These customers may be tempted to take their brokerage business elsewhere. “When holding several million shares of stock, you can visualize their reaction to a Street downgrade that drives the price several points lower,” McClellan writes.

That brings up another point of tension. The influence and compensation of Wall Street analysts are heavily determined by their annual ranking in Institutional Investor magazine, the powerful arbiter of excellence in Wall Street research. But who largely determines the analysts’ standing in the polls? The very portfolio managers whose business is vital to the brokerage firm. According to McClellan, securities analysts go out of their way to avoid alienating customers in the April-June period, when the Institutional Investor polls are open.

Given such bias in Wall Street research, you would expect statistics to confirm it. Indeed. Remember the Wall Street Journal “Dartboard Contest”? Each quarter, secretaries and other staff chose stocks by throwing darts at stock tables blindfolded. It turned out their random performance equaled the stock selections of expert Wall Street analysts. Another study tracked the performance of stocks that had been recently downgraded by Wall Street analysts. Over the next two years, this negative portfolio went on to vastly outperform the market.

The tone of “Full of Bull” is in no sense vindictive or bitter. McClellan clearly respects the profession he so passionately wants to reform, concluding with a list of sensible recommendations for change.

Nelson Freeburg is editor of Formula Research, a financial letter that builds and tests quantitative timing models for stocks, bonds, and commodities. Formula Research serves systematic traders and institutional money managers.

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