BUSINESSWEEK ONLINE : APRIL 3, 2000 ISSUE
Wall Street's Hype Machine
It could spell trouble for investors
David Talevi wanted to take hold of his financial future--and he did. The 32-year-old Talevi, who runs a trailer park in Wells, Me., decided to open an online brokerage account. It was easy--just as it was in the TV commercials. ''They talked about low-cost trades and ease of use. You can make a bunch of money--you heard them all, they're still playing them,'' he says. In the words of the young woman in the Ameritrade brokerage ad, he didn't just want to beat the market, he wanted to ''throttle its scrawny little body to the ground and make it beg for mercy.''
Talevi put a TV near his computer. He started buying and selling stocks featured on CNBC--only to find that the stocks moved in the wrong direction by the time his trades were executed.
He listened carefully to the CNBC pundits when the market turned sour in September, 1998. ''All the panelists they had on the TV were saying, 'This is it, we're finally right. The bubble's going to burst.''' So he bought a mutual fund designed to move in opposite direction to the market. And sure enough, the market went up--and his portfolio went down. He kept on watching CNBC and trading stocks through 1999. By the time he gave up in disgust, a few months ago, he had lost $40,000.
Welcome to the Wall Street Hype Machine. True, there have always been losers as well as winners in the stock market. But never before has Wall Street raised expectations quite so high--and never before have the media joined in quite so willingly as cheerleaders and stock-pushers. According to Competitive Media Reporting, a New York research firm, brokerage-firm advertising zoomed 95% last year, to $1.2 billion, and is now three times ad spending five years ago.
The brokerage campaigns that lured Talevi are part of a marketing juggernaut whose dominant message is simple: Wall Street can make you rich--and fast. There is only one problem with this message. For most people, it's just not true. So far the pain has been limited by the market's overall advance. But if the market turns south, the disappointment--and wreckage--will be considerable.
The media and marketing deluge has spawned a new type of Wall Street loser: the armchair momentum player. These are novice investors who engage in short-term stock buying and selling based on media reports or an expert's enthusiasm. It's an investing phenomenon that's far more widespread, faster-growing, and more troubling than day trading. Robin Dayne, a trading coach in Nashua, N.H., says investing has practically become a sporting event. And all too often, investors are getting knocked out of bounds. Says Dayne: ''Amateur momentum players are do-it-yourselfers who, unlike day traders, use no discipline or real trading strategy. They buy on the short-term tip and overwhelmingly get burned.''
PUBLIC FUNCTION. The bull market has caused a revolution in the role of the analyst, who is fast becoming less of a researcher than a celebrity pitchman--for both his employer and the stocks he or she follows. In this world, nearly every stock is a buy. And the analysts, in turn, feed on another aspect of the hype machine--the cable-television outlets and the exploding number of personal-finance Web sites, such as TheStreet.com and Marketwatch.com, that feed investors' appetite for up-to-the-minute information. To be sure, such media outlets serve an important public function by giving investors prompt updates on market and economic activity. But some have become conduits for stock hype.
Broadcasts from the floor of the New York Stock Exchange have propelled once-obscure financial journalists such as Maria Bartiromo to celebrity status and made CNBC to investors what ESPN is to sports fans. The stock exchanges themselves have vied for airtime almost as much as the analysts. The Nasdaq stock market will soon open a Disneyesque visitors' center adjoining its glitzy media showcase on Times Square--where huge stock tickers from Morgan Stanley Dean Witter (MWD) already compete for attention with billboards featuring half-clad supermodels. ''Wall Street has literally become embedded in our culture and everyday lives. The effect of the media on investor psychology is undoubtedly one of the driving factors behind the bull market,'' says Robert J. Shiller, an economics professor at Yale University and the author of a just-released book called Irrational Exuberance (page 20).
Of course, not all of Wall Street's pitchmen are peddling instant riches. A good deal of Street advertising promotes the kind of long-term investment strategies that have served investors well during the bull market--prudent stuff such as putting money in individual retirement accounts and 401(k) plans.
But all too often, the pitchmen are selling the notion that if you gain ''control'' over your financial destiny--pick your own stocks and execute your own trades--it will be the first step on a short road to riches. ''There is an intellectual component, which is, 'Hey, I'm getting a great deal,' and there's an emotional component, which is how I feel about myself when I take charge of my finances,'' says J. Peter Ricketts, Ameritrade Holding Corp.'s senior vice-president for sales and marketing.
COLD CASH. By now, the message is familiar, as are the not-so-hidden persuaders--the ubiquitous Stuart at Ameritrade (AMTD), the Charles Schwab commercials showing tennis players and sports stars spouting financial terminology, and the Morgan Stanley Dean Witter ad showing the truck driver who owns an island. (The ad, which is no longer running, was criticized by the Securities & Exchange Commission.) Merrill Lynch (MER) is unveiling an ad campaign for its online service at the Academy Awards telecast on Mar. 26, and even staid J.P. Morgan & Co. (JPM) is getting in on the act. The white-shoe firm has begun promoting its new Morgan Online Web-based private banking service in a campaign that will include TV ads, newspaper promotions, and even roadside billboards.
To get new accounts, brokerages have resorted to tactics ranging from saturation TV advertising to buying the right to putting their names on sports stadiums, such as the TD Waterhouse Centre in Orlando. E*Trade Group Inc. (EGRP), a heavy broadcast advertiser, has also entered into tie-in arrangements, offering new customers goodies such as subscriptions to America Online (AOL), tax software--and, at times, cold cash. It has offered rebates on merchandise of up to $400 in return for opening accounts with as little as $1,000.
The firm that arguably has the largest stake in the online marketing war is Schwab (SCH), and it has fought the online upstarts by using the time-tested route of celebrity endorsements. It has Ringo Starr working financial terminology into song lyrics, and tennis player Anna Kournikova and other sports figures supposedly obsessing over price-earnings ratios and portfolio theory. ''What they're trying to communicate is that really anybody can become smart about how to manage their money,'' says Susanne D. Lyons, Schwab's chief marketing officer.
Investors certainly need more knowledge to manage their money. Numerous academic studies have shown that amateur investors make poor traders--buying stocks for the wrong reasons, holding losers for too long, and acting on whims and emotions. According to the Consumer Federation of America, only 38% of investors know that when interest rates go up, bond prices go down. The CFA says that fewer than one in six investors understands that higher expenses, like commissions, can lead to lower returns.
Moreover, investors are fueling their purchases with borrowed money. Margin borrowing has climbed to record highs, and at yearend, margin debt represented nearly 3% of personal income, three times the historical norm, according to Sanford C. Bernstein & Co., a New York investment bank.
Investors are taking on unprecedented risk--and often, they have no idea what they're doing. ''Control is put forth as an unquestioned good, and the simple fact is that investors are not in control of the stock market,'' says Terrance Odean, a finance professor at the University of California at Davis and co-author of numerous studies on investor behavior.
POOR TRADERS. Odean and his colleagues have found that most investors trade poorly and perform worse the more they trade--systematically buying and selling the wrong stocks. And the move toward armchair momentum investing means investors are trading more and holding stocks for shorter time periods. A recent study by Sanford Bernstein shows that investors now hold an average Nasdaq stock for five months, vs. two years a decade ago.
The media at times, including BUSINESS WEEK, have fueled the explosion in do-it-yourself stock-picking and short-term trading by amateurs. This magazine's Inside Wall Street column, written by Gene Marcial, features three stocks per week, and the magazine's frequent personal-finance pieces often provide investment advice. In addition, in recent years a wide variety of personal-finance magazines have come on the scene, and all provide stock selections that often move the market. But the old-media financial news outlets lack the immediate market-roiling potential of the cable and Internet stock-pickers.
There's no escaping CNBC (GE). It is on almost everywhere during the day--from health clubs and airports to banks and bars. The popularity of the network, which features nonstop financial news during the day, has grown almost in tandem with the bull market. In the past three years, viewership has more than doubled.
CNBC is more than popular--it has become a cultural phenomenon. There are Internet discussion boards where investors can chat about the network. On the Silicon Investor Web site, there are 26 message boards with thousands of messages devoted entirely to chat about CNBC, with names like CNBC--Hunks of Financial TV and Squawk Box Trading.
CNBC provides prodigious up-to-the minute info and analysis on the stock market and investing. But it has become a mainstay of armchair momentum investors. Indeed, CNBC is sometimes a conduit for hype by its guests, who are predominantly analysts and money managers. Guests are expected to give stock tips. ''One of my worst experiences was when a new guest host, a strategist, told me he couldn't talk about individual stocks right before we went on air,'' says Mark Haines, anchor of the popular three-hour morning show Squawk Box. ''I thought, how are we going to kill the time?''
In fact, many of the 30 or so CNBC guests a day on shows like Squawk or Power Lunch are money managers who own the stocks that they discuss on air. ''This puts people on the line; if they own a stock, they should be able to defend it,'' says Haines. But CNBC has grown wary of money managers who pump stocks on the airwaves and then dump them, and has enacted an ethics code to help prevent such abuses.
Catering to traders, amateurs, and pros alike has long been CNBC's raison d'etre. ''It's inherent in CNBC's business model that they're short-term-trading-oriented, since what they provide is current or short-term news events and analysis,'' says Yale's Shiller. It comes as no surprise that CNBC's tag line is ''Profit from it.'' Responds CNBC President William Bolster: ''In 1956, a select few on Wall Street would have gossiped about the information we give out on Squawk Box. We've democratized the whole process, and that irritates the big shots.''
Maybe so. But some day traders use CNBC, and Squawk Box in particular, as a trading strategy--that is, buying or selling stocks when they are mentioned on the network, depending on the professed sentiment. Ken Wolff, the author of Momentum Trading and the owner of a Paradise (Calif.) day-trading firm, says he trades off CNBC info and instructs his clients how to do so. ''CNBC is a hot momentum-trading tool. We play it often--especially in biotechs, China plays, wireless, and fiber optics.''
Former CNBC commentator James Cramer has opined in his columns on TheStreet.com (TSCM) about the virtues of trading a stock when it is mentioned on the show. In a December column, he wrote: ''You take stock when you hear somebody is on Squawk,'' and he says that he bought 5,000 shares of Vitria Technology Inc. and profited in a matter of hours when ''Haines was promoting tomorrow's VITR appearance.''
The impact of a positive mention on the CNBC show has spawned a catchphrase in stock-trading circles: The ''Squawk Bounce'' is the quick upward momentum the stock gets behind it. ''Joe Kernen can make a biotech stock double in 10 minutes,'' says Wolff. A recent ''Squawk Bounce'' example: OSI Systems, an optical component maker, was mentioned by Squawk Box on Mar. 17 after a favorable newswire report, and swiftly jumped. Wolff's traders bought the stock at 14 1/2 and sold at 28--less than an hour after Kernen mentioned the stock. Then they shorted it when it started to fall. The stock is now trading around $18 a share. ''At least one of our traders made $12,000 on that CNBC mention,'' says Wolff.
But what about the amateur investors who were on the other side of that trade? ''They lost their shirts,'' concedes Wolff, who emphasizes that a strategy that can make money for professional traders can prove lethal for amateurs. This is especially true when novices trade small stocks with scant liquidity that are mentioned on Squawk.
According to a study by Bing Liang, a finance professor at Case Western Reserve University's Weatherhead School of Management, when ''experts'' recommend a stock in the media, the resulting abnormal returns and trading volumes are driven by ''noise trading from naive investors.'' And on average, investors following the recommendations lose 3.8% on a risk-adjusted basis over a six-month holding period. The study looked at stock recommendations from experts who participated in the Wall Journal's ''Dartboard'' column. And Liang's study shows that a typical stock recommended by one of these star analysts has higher-than-average volatility and price-earnings ratios.
TV TALENT. TV is also fueling the trend toward the ultimate stock-pickers and bull-market cheerleaders--''celebrity'' analysts and strategists. Whereas once the analyst role was filled largely by nerdy finance types who pored over numbers in virtual obscurity, analysts have become media-savvy spokespeople for their firms. When you think Goldman Sachs & Co. (GS), you think Abby Joseph Cohen (whose market calls have been correctly bullish). When you think Prudential Securities Inc., you think Ralph J. Acampora (whose market sentiments have been more mercurial). ''It's a great promotion tool for Wall Street firms. It's much cheaper to put an analyst in front of a TV camera and reach millions than to spend millions on advertising,'' says Erik Gustafson, a fund manager at Stein Roe & Farnham Inc. in Chicago. What's more, a study shows that companies are increasingly ditching the Wall Street firms that underwrote their IPOs when arranging subsequent stock issues, opting for brokerages that have a star analyst cover their company.
ENDANGERED. Analysts have long been criticized for their overly rosy view of the stocks they cover. It is an article of faith on Wall Street that a sell recommendation by a brokerage analyst has become about as rare as profits on an Internet outfit's financial statement. Studies show that buy recommendations outnumber sells by a staggering 72 to 1. The ratio 10 years ago was 10 to 1. All the difference cannot be explained by the bull market.
What's more, analysts are increasingly lobbing ''absurdly extreme'' calls that attract big-media attention and encourage momentum investing, says Dartmouth College Professor Kent L. Womack. Witness PaineWebber Inc.'s (PWJ) Walter Piecyk, the 29-year-old analyst who tagged an eye-popping 12-month price target of $1,000 a share on Qualcomm Inc. in December, when it was trading at 560. It remains to be seen whether Piecyk's call will pan out: After a 4-for-1 stock split, Qualcomm (QCOM) is trading at 134--536 before the split.
But the estimate has already paid off for Piecyk in the attention-grabbing department. Since making the call, he has been featured in at least 85 newspaper and magazine articles and has been mentioned 11 times on TV. ''When analysts make seeming outlandish calls, they're trying to make a name for themselves,'' says Gustafson. Adds Dartmouth's Womack: ''These days, a driving motivation behind analysts is to be known as the spokesman in their industry. It means promotions and more money. And when they reach this level, there's no question about their impact on stock prices.'' Womack says an extreme call tends to hurt an analyst only if it's both off the mark and bearish: ''If it's a bullish call, it often doesn't matter how much it's off.''
When it comes to celebrity analysts, few can move stocks like Mary G. Meeker, the chief Internet and e-commerce analyst at Morgan Stanley Dean Witter. Meeker is one of the analysts most in demand by the media, to the point that a company spokeswoman says the firm is now more selective about interview requests because ''Mary has to focus on her clients.'' Meeker says her celebrity status sometimes distorts the way she is presented by the press, which often magnifies statements she considers innocuous. Says Meeker: ''It's not always comfortable being sound-bited on things that are complex and highly risky.''
But her persona as a media darling still flourishes. Fortune named her the third most powerful woman in American business last year. Meeker has been on the mark about a variety of Internet stocks for years. Her first famous call was back in 1993, when she put a buy on AOL, which was trading at just 52 cents (split-adjusted).
When dealing with Net stocks that have no earnings, of course, stock-picking can be a tricky proposition. Meeker seems undaunted. Even though she stated in December that 90% of Internet stocks are overvalued, she has never placed an actual sell on a Net stock. ''We've been extremely selective on both companies we've taken public and recommended. It wouldn't be prudent to downgrade them,'' she says. In fact, she has a buy on all but one of the 15 stocks she covers, such as eBay (EBAY), Ask Jeeves (ASKJ), and Martha Stewart Omnimedia (MSO). The exception is AOL, which is restricted because of the pending merger.
That bothers some critics. ''When your job is to convince folks that a company with no earnings is a buy, and your reasons are pretty much all hypothetical, that's tough,'' says Charles Hill, director of research at First Call. At least Meeker is well compensated: She is said to have received a $15 million pay package last year.
Bullish sentiment or brilliant prognostications--or being the top analyst of the hottest stock sector--aren't the only things that make a media darling. ''You've also got to be able to deliver in a television format,'' says Deirdre Peterson, a media trainer who works almost solely with Wall Street clients. Although Peterson, a former vice-president for communications at Merrill Lynch, refuses to comment on her clientele, sources say she deals with blue-chip firms such as Deutsche Bank and Prudential Securities. Peterson says business has never been better. ''The whole CNBC phenomenon and the bull market have really made my business boom,'' she says. Peterson charges $3,500 a day for her services.
Peterson is struck by the fact that many analysts she trains are already media-savvy. ''I'm constantly blown away by how good these people are. They're used to doing their morning calls that are broadcast live via closed-circuit television around the world to their clients and brokers.'' Indeed, most brokerage firms and investment banks now have their own state-of-the-art TV studios for analysts to broadcast internally. They also have cameras set up on their trading floors for analysts and strategists to provide impromptu live feeds to CNBC and CNNfn.
''LIKE A PIZZA.'' Corporations' growing spin campaigns to push their stock, especially around the time they release earnings, also spur on the armchair momentum investor. Investor-relations departments used to handle routine shareholder requests and dealings with analysts. ''Now, investment-relations people are supposed to dress their stock up and sell it--like it's a washing machine or a pizza,'' says Matthew J. Greco, editor of Investor Relations Business.
Blame it, in part, on the proliferation of stock options, says Greco. IR officers are now charged with maximizing ''shareholder value''--i.e., driving their company's stock price upward. Because of this, IR pros, especially at Internet companies, have become masters of the press release--either inundating the public or spinning the wording to de-emphasize negatives. Market darling MicroStrategy (MSTR) is known as a press release ''blaster.'' It has issued 33 press releases so far this year--more than one every other business day. The software company's shares tumbled 62% on Mar. 20, with the announcement that it was restating its earnings.
First Call's Hill says the thing he sees most is tricky press release wording: ''It's designed to obfuscate--like leading people to look at numbers that aren't necessarily the ones they should look at.'' Hill points to a press release that Walt Disney Co. put out in January that focused solely on the rosy financials of the ''Old Disney''--that is, without including the company's bleeding Internet or ''New Disney'' divisions, which have their own separate tracking stock, Go.com. Still, Disney (DIS) retains 72% of Go.com.
And companies now put out bad news before their earnings are announced. Analysts then lower their estimates, and the announced earnings become positive ''surprises.'' Says Joseph Abbott, research director at I/B/E/S International Inc. ''That way, the company stays on investors' radar screens, especially those who do quantitative screening for companies with earnings surprises,'' Abbott says. Companies are also increasingly putting out press releases when their stock dips, reassuring investors that everything is fine, says Abbott. According to a source, the SEC is looking into how companies characterize their financials in press releases.
As long as the bull market roars forward, the press releases will continue to spew forth, the brokerage ads will continue to offer images of easy money, the business-TV pundits will continue to pontificate--and the public, with its growing propensity for short-term trading, will continue to lap it up. But if the market stumbles, the hype machine will have a serious problem. After all, ''taking control of your financial destiny'' makes a lot of sense--but only when stocks are going up.
By Marcia Vickers and Gary Weiss