Investing

Dire Warnings About Analyst Calls During Bear Markets and Broad Sell-Offs

In some instances analysts issue upside price targets of 50%, 100% or even exponential upside in their price targets. These generally are seen in very small companies rather than large ones. Quite simply, the mathematics of exponential growth simply favor small-cap stocks over companies that are already worth tens or hundreds of billions of dollars. These massive upside price targets usually come in biotech, technology and a few other sectors. They are frequently seen in fad sectors over time. And they are almost always in speculative companies with limited histories and that have high hopes in the years ahead.

It should be obvious that many of these super-high analyst price targets never actually materialize. Some companies fail miserably and their stock charts should be called a “crash and burn” pattern. Other super-high price targets do actually come to fruition, but it’s harder to expect that upside to happen during bear markets than in bull markets.

If all the quality stocks are trading lower each week, the performance of speculative stocks that are full of hope without any history can suffer greatly. That is frequently true even when there is no underlying change to a company’s future expectations. When analysts issue upside of 50% to 100%, or exponential upside, while the markets are selling off each week and refusing to go higher, these types of research reports should more often than not be kept in a drawer or computer file and reviewed once the market has begun to stabilize. Unfortunately, ignoring this lesson can and frequently does cost investors dearly.

Are there any instances where analysts have intentionally misled investors or gone off the right path? Sure there are, like in the dot-com bubble and in implosion cases like WorldCom. Regulators have tried to set up and enforce so-called Chinese walls between analysts and their investment banking and trading departments. The many reasons there should be obvious enough, but the most frequent or obvious would be on firms “front-running” calls. That is an example of when trusting analyst calls could go south in any type of market.

The topic of when to trust analyst calls and when not to trust analyst calls could go on and on endlessly (it’s actually a topic for one chapter of an upcoming book).

Investors should not ignore analyst calls in general. After all, many analyst research reports can bring great insight, detail and observations that most investors simply might not ever have thought about. Still, no one is perfect. Not even Wall Street analysts. At the end of the day, there is just a reality in bear markets that analysts are frequently behind the curve and they often only downgrade a stock after a large price drop has been seen.

There is another painful reality about bear markets that no one should ever forget, whether you are thinking about analyst calls or not — you are all on your own.