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 InstitutionalInvestor 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.
I n 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.