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Wombats in labyrinths

An illuminating discussion about sell-side analysts between Joe and Tracy led to these jottings:

Wombats in Labyrinths: the world of a sell-side analyst

“Analysts didn’t analyze anything. They were slaves to a team of corporate financiers, the men who did the negotiations and paper work (though not the trading and selling) of new issues of stocks and bonds for America’s corporations.” - Michael Lewis, Liar’s Poker

“If you steal from one author it’s plagiarism; if you steal from many it’s research.” - Wilson Mizner

Not just big banks and brokerages, but analysts of even rating agencies trot around with a touch-me-not air these days. There aren’t a lot of axes to grind in the media business, but I’ve been sharpening mine to hunt down the analyst wombat, a creature burrowed deep in a labyrinthine hierarchy meritocratic enough to make an HUF business empire look like a mom & pop store.

A typical analyst wombat is no different than the rest of us, accidentally trapped in a field of perpetual cognitive dissonance. He wants escape, but the only way out is through, so he does the menial job - producing specialised content for niche audiences. What makes the analyst interesting is not the function he performs though, it is rather his location in the financial ecosystem that catalyses the utility of his function. Perched between the markets and participants, like a real-life maxwell’s demon, condemned to separate hot “molecules” from cold.

I don’t know how much time their profession can borrow before artificial intelligence starts eating up into the market share for their skillset, but as a (humble) programmer, I believe it will become commercially scalable before an AI is able to write its first New York Times bestseller.

I’d like to believe that the wombat, too, is deeply aware of this threat, most of the time.

He tries to be polite, but wants me to call after the market closes.

The journalist is little more than an NPC in the analyst’s viewport, another sprite to bump against expecting little more than a rumor-shower or PR mushrooms. And yet, developing the right analyst sources is key for the journalist’s survival (at least as a rookie).

Meanwhile, oligarchies of primary sources, in the form of closed whatsapp groups, clamour for the journalist’s attention, blathering ad infinitum and at an intensity that leaves useful signal about as visible as a needle in a noisy haystack.

At the other extreme are oligarchies of big ticket rating agencies, banks, and brokerages that produce research that nudges financial media and the markets in much the same direction. Kinks of financial journalism (pdf) aside, the whole system feels rigged in a way a single instance of a confirmation bias can round-trip and trigger disasterous multipliers before checks and balances kick in.

News expires more rapidly than most people think, but the sell-side analyst hardly cares, because his original research virtually renders him a market-maker in this derived information symmetry.

All this gives the analyst in the labyrinth a holier-than-thou confidence, I don’t think anyone who finds themselves at the start of a food chain can ever escape becoming spiritual. So once an analyst makes it big, the quid-pro-quo is more apparent, supply readily meets demand, the linen gets washed.

Anyone desirous of a real scoop must still continually pump the lines with cold calls to get information. That, and legwork.

But why must it be that way?, not that I mind cold calling, or legwork, but here’s what The Economist had to say about the accuracy of equity research):

Normally only one change in ten in analysts’ stock recommendations moves the price of the share in question. But the proportion increases to one in seven in falling markets, even though there are more changes during market routs.

Matt Levine explains the two models of sell-side research beautifully here, leaving it beyond scientific doubt that this beast is actually an agent of the dungeon_master, making his way up his master’s ladder, minting him gold in the process rather than acting cute for charity, as was earlier held by some.

Think of it this way, if the job of the analyst is to disemminate truthful information, how are they any different from journalists except in detail, prose-complexity, and jargon?

This 14% at-best claim on the edge has proffered a veritable information-recycling industry in a parasitic relationship with host economies. As banks cut corners to increase provisions for the next inevitable bust, governments prop up legislations like MiFID, as offsets.

A barrier-to-entry at their worst, the BUY, SELL, and HOLD spells of the analyst usually end in little more than esoteric smoke and arcane mirrors for the investor - but to the banker the customer appears tantalised with the wizardry and added value. The media reports with little enthusiasm or aplomb and the audience admires his expensive tools and potions. All in a day’s work for Dobby.

Perhaps a motivated commoner can get a 10-14% average alpha in a any market if they apply themselves and do their own research, as Poninju Veliath says- “make your own nifty”, but still, sell-side research will continue to exist because individuals are too lazy and organizations need lambs.

I don’t mean to disparage the sell-side research industry, even though a lot about it reminds me of the private tutoring industry, but there is simply so much information overkill in this medium that the message rarely makes it out alive, which is to say it fails to deliver any real edge. The market being served here is one that demands several layers of procedural redundancies and decision-support failsafes, this is not a market for innovation and certainly not one for news.

The analyst’s disciplined approach is something to be admired. It imbues his research with objectivity, but when quarter upon quarter one is faced with predictions, estimates, and recommendations which either tow the broader market line, or are so far removed from what actually occurs that one can’t help becoming skeptical of the output, and apathetic of its claims.

I’m not saying lubricating the market’s cogs with “premium mediocre” snake oil is unethical, but if access to the snake oil is made easier, more people and the market could benefit. If competition is truly fostered (with more freebies), if feedback and analytics are opened for investor recourse, and if the simple investor is invited more often into the secretive world of the wombat-analyst, perhaps then, sell-side research may survive as something more than a footstool for automation.

  • This is a groundhog, which is a marmot, not a wombat, wombats are marsupials.

Further Reading