Trust but verify: Watchwords when using broker research

By HAROLD GOLDMEIER
October 21, 2013 21:49

"Do not love an investment because of what people say about it. Love it because of what you understand about it.”




BASTION OF CAPITALISM: The New York Stock Exchange

New York Stock Exchange R370. (photo credit: BRENDAN McDERMID / REUTERS)

When the investment markets tanked five years ago, singles, families and retirees took a beating. They watched their portfolios drop 40 percent to 75% before the shock wore away and they were able to pull the trigger to sell off stocks that were sliding into the abyss. The Dow Jones righted itself and surpassed 15,000 with small investors flooding back. Memories are short when greed bubbles, and fear of missing out on opportunities prevail.

Six years ago, October 2007, the Dow reached an all-time high 14,164. Six months later the Dow was down to 11,000 on bad economic news. In September 2008, Lehman declared bankruptcy; edacious banks pulled nearly $150 billion from money-market funds, and the market nearly collapsed. By March 2009, the Dow was a paltry 6,594.

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Devastated small investors vowed, Never Again! The Wall Street Journal interviews reported responses such as, “I hit rock bottom,” and “We just got our brains beat in.” Fund tracker EPFR Global reported that between 2009 and the end of 2012, small investors pulled more than $200b. from stock and exchange-traded funds.

Today’s low interest rates are a facile tool of worldwide central banks that stimulate borrowing at lower costs for economic investment and business expansion. The Bank of Israel, eyeing a slowdown in business activity without fear of inflation, is leading the way by lowering borrowing costs again in September.

The downside for small investors is a measly interest rate for their cash and the chipping away at their purchasing power.

When the dollar is devalued, trading them for other currencies makes out-of-country vacation travel more expensive. The alternative for small investors? They are back in a serious way and have returned more than $29b. into the markets in 2012 and 2013.

Self-directed investors, teachers, plumbers, electricians or workers in computer fields, with small amounts of money to invest, rely on instinct and some research. Listening to the buzz about the company shapes instinct; they listen to the talk from friends, news reports and Internet gossip touting the industry and company products, believing they have enough knowledge to make wise choices.

Brokers who make buy/sell recommendations do in-depth analysis and have access to data and informant information not easily available to the public. Their fiduciary responsibility is to investor clients who value the recommendations of brokers to maximize returns on stocks, mutual funds, collectables, art, coins and crops. Those recommendations are based on information, experience, fundamental and technical analysis without profiting from client investment decisions.

Here are some guidelines to client/broker relations valuable for any investor in the recently published Gale Insights Handbook of Investment Research from Gale Cenage Learning. A research broker analyst and brokerage firm must work at arms length and not profit or receive other benefits “from the use of the research when clients make investment decisions.” In-house analysts are forbidden to profit from management investment choices based on the research. Independent analysts who sell their research must disclaim that their work constitutes an offer or solicitation for buying and selling.

A small investor might rely on fundamental analysis. For instance, ancient Greek speculators listened to public complaints and followed data on starvation incidents and crop harvests to make their fortunes by calculating supply and demand to know when to buy and sell crops. Today, rainfall, farmer storage capabilities, truck driver strikes and government interventions on price supports are followed carefully as well.

Technical analysts primarily use computers to chart prices and market trends to determine a stock’s price. They factor in production numbers, sales data, costs of manufacturing, consumer confidence numbers, employment trends, inventories, new housing starts and permits, for example.

Regardless of the type of analysis, an investor has to know that the broker is supplying information that is in the client’s best interests. The US Securities and Exchange Commission fined one bank nearly $1 million for breaching firewalls established in the firm’s written corporate manuals for not separating the equities capital-market staff from research analysts.

Research data on new stock issues called IPOs need to be especially transparent. Everyone wants in on the ground floor, but not all IPOs are successful. Facebook opened at $38 per share.

Three months later the shares sold for $19, and the company lost more than $40b. in value. Some people knew of lock-up agreements that created downward pressure on the stock price.

The information was not generally shared with the public.

Underwriters and insiders were able to sell millions of shares they received at near-high opening prices along with management fees. If a small investor knows where to look, the information might be a deterrence. New research on the digital tech industry added to the pressure that resulted in many small investors being wiped out.

Small investors must research the broker and brokerage firm that handles their accounts with the same tenacity they use to look into potential investments. Know their track record, know their equity holdings – and compare them to the recommendations.

Lawsuits and complaints filed with the government are public record, as are complaints filed with the New York Stock Exchange, Nasdaq and most other exchanges. Know how many years the broker has worked and for how many different firms.

Commissions and fees can be negotiated. Do employees do research, or does the firm buy from outside sources? Speak regularly with managers to keep abreast of the brokerage firm’s stability and positions in the markets. This is called broker tracking.

The Gale Insights Handbook warns: “There is little hard evidence that broker research is any more or less valuable, honest, reliable, or transparent than research on other financial investments...Do not love an investment because of what people say about it. Love it because of what you understand about it.”

Dr. Harold Goldmeier is the managing partner of Goldmeier Investments LLC and an instructor of business and social policy at the American Jewish University, Aardvark Israel Gap Year Program, Tel Aviv.


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