The herd mentality of brokerage firm analysts often plays a substantial obstacle to successful investing according to neuroeconomist and behavioral finance presenter Barry Ritholz, CEO of Fusion IQ and author of The Big Picture blog.
It is a human defense mechanism to blend with the crowd. Analysts who go against the herd stand out. If their contrarian opinion turns out to be correct, they are praised. If not, they are easy targets for ridicule, and they are more likely than herd followers to be fired, Ritholz says. Thus, most analysts settle for average rather than take a chance with their own opinions. Maybe it is a recognition on their part that, like hedge fund managers, they only occasionally beat the odds. Or maybe there are other more sinister reasons.
The herd clearly has a “Buy” bias. Earlier this year, not a single one of the S&P 500 index stocks had a consensus sell recommendation. Some stocks had the odd “Sell” recommendations, but most analysts said “Buy.”
Why is there a “Buy” bias instead of a “Sell” bias? Ritholz says it is not news that many analysts work for firms that receive big revenue from advising and managing offerings of the companies they rate. Those companies do not like “Sell” ratings placed on them, and if that happens, there is a good chance that the analysts’ firm will lose that business, and the analyst may be fired.
This bias has risen to the level of fraud. In May 2008, Ritholz writes, only 5% of Wall Street recommendations were “Sell.” The infamous “lipstick on a pig” quote dates from this time and is associated with former Merrill Lynch analyst Henry Blodget, who (among others) placed “Buy” ratings on stocks he privately derided. (Blodget was subsequently barred from the securities industry.)
Ritholz concludes: “It looks like there is still lots of lipstick on Wall Street.” Put another way, thanks to Wall Street’s aggressive lobbying and political donations, it is business as usual on Wall Street.
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