American Investment Services, Inc.

Disciplined, Diversified, & Cost Effective

May 2003 – Minding Wall Street

In late April regulators announced the final terms of a deal reached with ten Wall Street securities firms following a two-year investigation of analysts’ practices. If the intention was to restore faith in Wall Street, count us among those who consider the deal a failure. The market showed no immediate reaction; the major indexes hardly reacted following the announcement.

The terms of the settlement include fines totaling $1.4 billion and disciplinary action against two well-known analysts. New rules were also established that will supposedly keep separate the work of analysts and that of their investment banking colleagues. The regulators found that analysts’ compensation was directly related to their willingness to report “buy” ratings for high-risk stocks that the investment banking side was selling to the public. Internal documents were made public that revealed blatant efforts to exhort analysts to tout such stocks. In our view it is this shedding of daylight that will have the most impact by enabling the market to apply its own discipline.

The settlement also called for the ten firms to establish a $432-million fund to finance outside, stand-alone analysts who will generate reports to be published alongside those of the firms’ own analysts—ostensibly to dissuade the latter from issuing biased research. We believe that this arrangement will do little to improve the image of Wall Street analysts. It is questionable whether these stand-alone firms will remain any more objective than the “inside” analysts; after all, under the terms of the deal the independents still must contract with firms that derive the lion’s share of their revenues from underwriting securities.

The settlement amounts to little more than an attempt to ensure that in the future worthless recommendations will be derived in an unbiased fashion. Even assuming objectivity is maintained, the sort of analysis propagated by Wall Street is simply not worth anything. Mountains of studies demonstrate the futility of attempting to pick “hot stocks.” In our view there is a huge burden of proof upon anyone who asserts that he possesses a unique ability to consistently exploit publicly available information in order to trade stocks profitably. Investment research should instead be confined to an empirical review of asset-class behavior over the long term.

We suspect that the story is hardly over, and that as events unfold investors will increasingly turn to structured investing rather than rely on the whims of “professional” stock pickers. We have great faith that while individual investors cannot outsmart the market, most are smarter than Wall Street.

Also in This Issue:

Gold Market Survey
The Washington Agreement on Gold (WAG)
Quality Gold Mining Companies
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow-Jones Industrials Ranked by Yield