Investors who manage their own money in the stock market should always be looking for signals from multiple sources to try to gain perspective and clues as to which direction the market is headed.
There are four main sources of information to look at:
1. Wall Street
2. The government
3. The media
4. Independent analysts
Each group can provide valuable information; however, each group can also provide erroneous information! Our job as individual investors is not just to figure out where to find information; it is to evaluate information. The evaluation process is not solely limited to determining if and how the information will affect the market, but also to determine the legitimacy of said information.
There are several factors that should be considered when weighing the legitimacy of information.
Our first source of information, and the one we will focus on here, is Wall Street. Wall Street has analysts who give us their opinions about several fundamental aspects of a company’s financial situation. The most commonly followed piece of information they provide is earnings estimates.
For a long time, a company’s earnings were compared to the earnings of the prior quarter. Then, seasonality became a factor — a worthy factor, in my estimation — and earnings for a specific quarter were then compared to the earnings of the same quarter a year earlier.
In either case, when comparing quarter to quarter, or the present quarter to the same quarter a year ago, we were looking at real numbers — real growth or real contraction.
Then the Internet came along. Brand-new companies with brand-new technologies burst onto the scene. There were so many of those new companies, and they appeared so quickly, that most went public with very little earnings history. Most were spending big money to fund undeveloped ideas in the hopes of future success.
No one knew whether or not these companies were on the right track or not. Some would go on to be among the biggest, most successful companies we know today. Most, however, would disappear as quickly as there appeared.
Most of the latter companies consistently reported losing quarters. The problem was how to judge which of the then-losers stood a chance to become a winner.
So, with this new situation developing, Wall Street decided to usher in a new era of determining how to analyze earnings, and lo and behold, we have earnings estimates.
Now a company’s success or failure is no longer determined by how it is doing based on real numbers. Its success is determined by how Wall Street thinks it is doing based on arbitrary numbers determined by Wall Street!
Did Wall Street Ever Have Noble Intentions?
Looking back at it, the introduction of earnings estimates was probably the right thing to do at that time, when so many companies had very little to no earnings history. Wall Street had to give some guidance.
However, like many ideas that start off good, greed has a way of making them turn bad. Remember the saying, “The road to hell is paved with good intentions.”
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Suddenly, the indications of whether a company was doing well or not was defined by Wall Street estimates and not determined by real performance. Wall Street had the way it needed to make companies look strong, even when they were not — making it easy to raise money for them and, in the process, making it easier for Wall Street itself to make money.
They say that the proof is in the pudding. My bold statement needs to be backed by some fact to be legitimized. My pudding is the latest market sell-off caused by — or, at least, started by — a collapse in the subprime debt market.
No ‘Sell’ Ratings!?!
We are all familiar with the story about how that crisis expanded and led to problems in the housing market and, finally, a full-blown credit crisis that destroyed such mainstay firms and institutions like Fannie Mae, Freddie Mac, Bear Stearns and Merrill Lynch — not to mention the others that were brought to the brink of extinction.
Here, in what has been described as the worst condition since the Great Depression, the Dow Jones Industrial Average (DJI) traded down from 14,200 to a low of just below 6,500, a whopping 54% drop in less than a year.
During that entire time, did you know that fewer than 5% of all stocks had an analyst’s “sell” rating on them?
This fact seems totally ludicrous to me.
How can Wall Street, involved in this mess up to their necks, knowing their own exposure as well as the exposure of all the major companies out there, not know this was happening?
On top of the ratings that Wall Street had on the market, how was it that these companies were still beating their Wall Street estimates while the economy was tanking, numerous major firms and institutions were going broke, and smaller companies wiped out by this crisis?
Something smells rotten here.
Wall Street Deceives the People Who Must Save Them
Could Wall Street have been so wrong in their evaluations of the overall economy and individual companies in that economy? I mean, how could these “experts in the market” be so wrong and leave themselves so dangerously exposed that it took the individual U.S. taxpayer to bail them out?
It is one thing for Wall Street companies to put themselves at blind, naked risk. It is another thing to put us — their clients — at risk to anywhere near that level.
Why they would do it is a topic for another conversation. The “how” they would do it is what is important here.
Wall Street gets paid when you put money into the market. They make their money when you give them your money to invest. Honestly now, are you more likely to invest in the market when it is going up or down?
Although money can be made with the market selling off, the majority of investors will tell you that they invest when the market goes up. Wall Street knows this to be true. Whether it is through brokerage or investment banking, Wall Street makes money when the market goes up!
It is in their best interest to see the market going up so much so that they will do everything in their power to influence the market to get moving upward — including, but not limited to, lowering earnings estimates so companies can beat estimates and appear that they are doing well and handing out “buy” recommendations like toilet paper.
Moral to the story: When listening to information from Wall Street or a Wall Streeter, make sure that you know that Wall Street has its own agenda — one that can only be met by a rising market. And this can only be attained by you and me investing money into the market … and that will only happen if we are confident that the market will go up.
Wall Street, in its insatiable quest to make the market go up, knows that this will only happen if the investor is confident. So, the news from Wall Street — while not an outright lie — is skewed bullish.
As an investor, we need to rely on news and information. When receiving information from Wall Street, make sure you consider the source.
Related Articles:
- How to Profit From the 10 Biggest Wall Street Lies
- 3 Emerging Market Bubbles Ready to Burst
- Why Wall Street Needs More Financial Regulation
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