There's an old joke on Wall Street: God invented analysts to make weather forecasters look good.
Meant as a tongue-in-cheek poke at the complexity of financial markets, it's unfortunately all too true.
Most conventional analysts are often myopically focused and very close – too close – to the companies they cover. More often than not, they fail to see critical product developments, miss industry-specific competitor information, and appear blind to basic common-sense developments that could materially affect stock prices.
Worse, they're often bullish when they should be bearish and bearish when they should be bullish.
Like lemmings, they'd rather go off the cliff together. The fact that they take millions of unsuspecting investors with them is an afterthought.
That's bad if you depend on them – but great if you know how to pounce on the openings they inadvertently create.
We've talked about this several times over the past year with great success. Each time, you've had the opportunity to rack up double-digit returns on analysts' "mistakes."
This time around, though, I think the potential may be even bigger…
What Happens When You Follow Lemmings
Enron is perhaps the most egregious example of what I am talking about.
More than 50% of the analysts following the company rated it a "Buy" or a "Strong Buy" even though it had fallen from a 52-week high of $84.87 to only $0.61 by November 2001. Worse, two analysts still rated the company a "Buy" and two still had it as a "Strong Buy" after the company was scheduled for removal from the S&P 500 Index.
And look at General Electric Co. (NYSE: GE). In 2007, GE was struggling and had fallen from a high of nearly $60 in July 2000 to just under $40 by mid-summer. Yet, several analysts still rated the company a "Buy" even as the financial crisis began to rattle global markets. One European bank, in particular, rated the company a "Buy" and continued to do so all the way to $10 a share, when it finally changed its rating to a "Short-Term Sell," according to MarketWatch.
It'd be very easy to call these folks stupid or use far worse language. But that wouldn't be true.
In fact, most analysts I've met are exceptionally intelligent. Many have graduated from a top-tier university even as others have come up through the school of hard knocks.
So what gives?
Wall Street is an insider's game. "They" have a long history of saying one thing and doing another.
Do you really think an analyst is going to tell the truth about an overvalued stock like Enron or GE if his firm is engaged in a $500 million financing for that same company? No way.
It's just as bad when it comes to undervalued companies.
For example, Sketchers USA Inc. (NYSE: SKX) blew the doors off earnings this past April, yet analysts remained bearish. After a 113% run higher, that same rating changed to "Neutral" then ultimately a "Buy," but only after yet another 24% move higher. Had you listened to the analysts posting those ratings, you would have missed a 182.8% move from $29 a share to $82 a share. Ouch!
Lately the game's become more refined. It's all about expectations now that QE's done and a Fed rate hike looms.
This earnings season, companies that beat are enjoying an average increase of 1.5% over the following two days, according to FactSet. Companies that miss are punished to the tune of a 2.5% drop.
Nobody seems to mind that the bar is set so low at the moment that a limbo dancer would find it problematic.
But that's your opening…
Every misfire is an opportunity to react to hidden cues, blind spots, or simple bias.
About the Author
Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean, and he's also the founding editor of Straight Line Profits, a service devoted to revealing the "dark side" of Wall Street... In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.