Wednesday, 15 June 2016
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Why Brokers say "BUY!"

It is well known that despite all the brain power collected in our industry brokers almost never say sell.

I remember the broking firm I worked at in the UK 30 years ago losing the number one rated media analyst because he wrote a piece of research on Maxwell Communications entitled “Can’t Recommend A Purchase” (get it?). We were Maxwell’s broker and the analyst was trying to say sell, with good reason as it turned out. Robert Maxwell rang up and insisted he be sacked. He was. Even though he was right. Robert Maxwell later fell off the back of his boat and his sons picked up the flak for a massive misappropriation of funds from the Maxwell companies. The analyst was swiftly employed by another broker on a bigger salary and remained the number one media analyst.

Although research is often very thorough, and essential reading for those wanting to form their own opinion, the headline recommendations, which are the sole focus for many, rarely communicate the story. There are a myriad of reasons, the main one being that the big bucks for big brokers come from corporate fees not getting stock recommendations right. They are commercially more interested in getting paid a lot to issue shares and raise capital than they are in earning a little through commission from small clients. 

It is after all the core reason the stock market exists. And to think you thought the market was there so you could invest. No, it is there so companies can access your money. Part of that process is brokers endearing themselves to companies to get the job of raising capital and the fees that go along with it. Corporate purpose is paramount and on that basis any sell recommendation is simply an admission from a broker that they have no chance of getting a corporate fee from this company.   

In order to combat the criticism that nothing’s a sell, some brokers have overlaid their research with recommendation systems based on a formula with an intrinsic valuation at its core. But it is a cop out. Rather than offering insightful human opinion and having a view they are using an algorithm. If a share price strays X% below the valuation it becomes a ‘Buy’. If it goes X% above the valuation it becomes a ‘Sell’. The rest of the time it’s a hold. The net result is a blameless research department and the appearance of activity where there is none through a lot of recommendation changes. But the system is flawed because it is not an expression of opinion, a core expectation of research, but a reflection of price. In a volatile market a stock can become a sell one day, a hold the next and a sell again the next day as stocks that go up become sells and those that go down become buys. It is a system that relies on mean reversion rather than trend, and that cuts across the core tenet of almost all technical analysis, which is to follow the trend not bet against it.

Net result, when research use a recommendation formula, recommendation changes, which used to be an interesting value add from brokers, become hollow. You cannot replace insightful value adding research with an algorithm.

And there are other reasons broker research doesn’t say sell. Because the companies love you. Because statistically it is more likely to be right as share prices go up in the long term. Because you can ring all your clients not just the shareholders and because saying buy is a positive message which is much more easily delivered, received and acted upon. People like to hear about hope not failure, it’s good for commission.

The market is alive with corporate deals at the moment. So much so some fund managers are forgetting which ones they’ve said yes to and when the money is due. Brokers are ringing any and everyone telling them to list or take advantage of their share price to raise capital. Everyone’s saying buy except the algorithms. The higher prices go the more sells they have but in a recovering market they are doing themselves and their clients a disservice.

Bottom line, read the research, form an opinion, but ignore the advice. 

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