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Analysts' tougher ratings taking toll
Be careful what you wish for -- at least on Wall Street.
Stock analysts, under siege for their perceived lack of forthrightness, now are downgrading shares and issuing outright "sell" recommendations at a much higher clip.
Trouble is, their growing cascade of negative opinions is arriving when the stock market -- already trading near five-year lows -- least needs to hear it.
"It couldn't have come at a worse time," said Chuck Hill, research director at Thomson First Call, a market data tracker in Boston.
Stocks including General Electric Co., Electronic Data Systems Corp. and Ford Motor Co. have been pummeled in recent weeks after they were downgraded by brokerage analysts, weighing down the broader market as well. Even a ratings cut from "buy" to "hold" can trigger heavy selling, depending on who's talking and who's listening.
More analysts also are advising investors to get out of some stocks entirely. "Sell" ratings have hit such shares as United Airlines parent UAL Corp., golf equipment maker Callaway Golf Co. and power company Duke Energy Corp.
Overall, "sell" ratings have jumped to more than 8% of the approximately 24,000 total recommendations made by analysts, a fourfold increase from earlier this year, Thomson First Call estimates. The 8% figure includes such ratings as "under-perform" and "underweight," which mean basically the same thing as "sell," Thomson said.
And more downgrades are coming, Hill predicted: "As time moves on, we'll see a further shift upward" -- meaning more "sell" ratings -- "as more analysts say what they mean."
True, analysts still are urging investors to buy or hold more than 90% of all stocks -- and their influence still cuts both ways. Analyst upgrades or positive comments about IBM Corp., Oracle Corp. and other tech stocks helped fuel the market's strong surge Friday, lifting the Dow Jones industrial average 316.34 points to 7,850.29.
The Dow and other major indexes rose last week after six straight weeks of losses that had pushed prices to five-year lows.
But analysts' newfound imperative to get tough -- or at least look tough -- could help assure that the 31-month-old bear market drags on.
For instance, investment ratings on fast-food purveyor Yum Brands Inc., parent of Pizza Hut, KFC and Irvine-based Taco Bell, were cut by some analysts Thursday amid fears that Yum's sales growth is slowing. None of the analysts issued a "sell" or its equivalent, but the stock plummeted 21% that day, and shares of rival restaurant companies fell in tandem.
The plunge in Yum shares shows that, even as many big investors say they don't believe Wall Street, analysts' recommendations continue to carry weight.
Until this year it was rare for "sell" ratings to account for more than 1% or 2% of all analyst ratings. That's what got analysts into trouble: As the stock market's bull run neared its peak in early 2000, it wasn't easy to find a "sell" despite the adage to "buy low and sell high," and even though some skeptics were warning that many stocks had soared to absurdly high levels.
Even as prices collapsed in 2000 and 2001, "sell" recommendations were still hard to come by. That began to change only this year -- after many stocks already were down 50% or more from their peaks.
In spring, regulators and lawmakers stepped up investigations of whether analysts had been pressured into staying overly bullish about companies for fear of losing the firms' lucrative investment banking business.
Wall Street reforms stemming from those probes have included simplified ratings at most brokerages, whereby analysts now are largely using just three calls -- "buy," "hold" and "sell" -- rather than the multitiered ratings structures that often left investors confused about exactly what the analyst was recommending.
With the simpler ratings structures, analysts increasingly are downgrading stocks to "hold" or "sell." Morgan Stanley, one of the first firms to reform its ratings, now has about 20% of its recommendations in the "underweight" category, which for many investors' purposes is the equivalent of "sell."
But as downgrades increase, the shift has opened a debate over whether analysts are giving a more honest view of what they expect to happen to companies and stocks or whether they are merely piling on, largely reflecting bad news that already is in the market.
"People who put a 'sell' on a stock when it's down 50% are OK, but you'd better be predicting something that's worse than what's already happened," said Bob Smith, manager of the $3.3-billion T. Rowe Price Growth Stock Fund in Baltimore.
The point is, he said, that ratings should indicate whether a business is having short-term problems or is locked in a long-term downward spiral.
"In the same way that 'buys' in 1999 tended to be about one-third really insightful, one-third [analysts'] riding momentum and one-third nonsense, I think it's about the same on 'sells' " now, Smith said.
He noted that in European markets, outright "sell" ratings by analysts have long been more common, but their usefulness is questionable.
That's because "if the stock goes two points higher, they put out a 'sell.' Then they do the reverse, and they whip the prices around," Smith said. "So if it's used poorly, it's of no value."