Investors, too, carry big sticks, and, like companies, don't hesitate to swing them. Major fund companies pay the Street hundreds of millions of dollars a year—way more than even the biggest banking clients. When a fund company owns, say, 5 percent of GE, and an influential brokerage-firm analyst trashes the stock, the fund managers don't usually call the firm and say, "Thanks for the tip." Instead, they usually say something like, "Your analyst is an idiot, and thanks to his big mouth, our funds will be down this morning." An analyst who routinely takes potshots at an institution's holdings won't be regarded as helpful for long, especially if he or she is wrong. (If the analyst is right, that's a different story, but the institutions have analysts, too, and if they thought the brokerage analyst was right, they wouldn't own the stock.)
These realities create what might be described as Pascal's Wager for Brokerage Analysts, a risk/reward equation that, when everyone else is positive, makes it risky to be negative:
- If the analyst is positive and right, he or she gets one point (it's good to be right, but others usually share the credit).
- If the analyst is positive and wrong, he or she loses one point (a black eye, but others share the pain and blame).
- If the analyst is negative and right, he or she gets three points (companies and investors scream, but everyone respects a good call, and sooner or later they'll come groveling back).
- If the analyst is negative and wrong, he or she loses ten points (companies, investors, and bankers scream, the stock rises, and, in addition to trashing relationships, the analyst becomes the village idiot).
There is a final reason for the current ratings disparity, one that requires some historical perspective. As Warren Buffett has observed, most investors make decisions based on the "rearview mirror": Specifically, they expect more in the future of what they have seen in the recent past. In 2000, when fewer than 1 percent of stocks were rated "sell," the market had been rising for 18 years. Analysts, investors, brokers, and commentators under 40 had experienced nothing but a bull market, and those over 40 could be forgiven for thinking that the nasty '70s were, thankfully, ancient history.
Long bull markets breed optimism: Investors are far more bullish at the end of them than at the beginning. The last few years have been painful, but the memories of 1982 to 1999 remain fresh, and most analysts and investors still expect a return to this happy trend. Unfortunately, as Buffett has also observed, the rearview mirror is not a crystal ball. In 10 years, if the market has remained stagnant, investors and analysts will gradually get more bearish, and the percentage of "sell" ratings should finally increase.