This article serves to explain the following – via a real-world example:

• why we mistrust most of what we read in the financial press / on TV. Why you should as well.

• why we don’t get excited about roaring stock markets when they are not based on evidence that is rational or defensible.

• how investment policy is implemented.

It has always been the case that Wall St analysts have far more “buy” ratings on stocks than “sell”. Here is a true story of why that is. This also speaks to why we have the views we do. As a matter of context, I used to work for a national brokerage, and have seen the “sausage being made”.

In April this year, an analyst – Brian Kennedy – at Jefferies & Co. slapped a “Sell” rating on CardioNet Inc. The poor sap (Mr. Kennedy) was a newbie to the game and thought has was supped to do research, interpret the impact, and publish the results as something investor clients could use: buy, sell, hold. His research concluded that CardioNet would be adversely impacted by a coming change in Medicare reimbursement that would directly impact CardioNet’s revenue from remote heart monitoring product. For Mr. Kennedy’s effort, he was rewarded with a complaint to the SEC brought by CardioNet; was made the subject of an in-house investigation; and received abuse from company management and competitor analysts. He had to leave Jefferies & Co.

Those that heeded his report avoided losing 75% of their money when CardioNet’s stock was pummeled after it became clear that (guess what?)– CardioNet’s revenues were being pummeled from the change in Medicare reimbursement.

Jefferies & Co follow the Wall St pattern of ratings :

• 7-8% of ratings are sell

• 48-53% are buys

• 39-44% are holds. Look a little lop-sided?

Just prior to this research report, Citigroup analysts had their highest positive rating on the stock: a screaming conviction BUY. After Mr. Kennedy’s report was released, Citigroup came to CardioNet’s defense reiterating their conviction buy rating- as did other Wall St analysts. Care to guess why Citigroup was so bullish on this stock ? Answer: (as some of you probably guessed) Citigroup was one of the underwriters of CardioNet’s IPO a month earlier. As such, Citigroup made a great deal of money on the IPO. As part of the IPO deal, it is their job to be head cheerleader (hype the stock so unsuspecting investors will buy it). Well done Citigroup. This sort of sleaze used to be commonplace in the tech boom. Recall some of those analyst superstars were forced to retire with their $millions –out of shame for their acts.

We will be watching the Wall St Journal to see if the SEC brings suit against anyone at Citi for their actions. We are not optimistic though. Last week, the US Gov’t lost their case against the 2 hedge fund managers at Bear Stearns that helped to bring down the financial system with their large bets on mortgage backed securities. Unflattering emails were found. Not enough, apparently.

So when you see someone on TV talking-up a certain stock, fund, sector or even market, take it with a grain of salt. Most of the time these are the same brilliant investors that were talking the market up in September 2007.