Defending the Squid

The Blogotariat is up in arms on the subject of Goldmans latest evilness-itude. Goldman Sachs, apparently, blatantly favours clients that pay them more money. Baruch is shocked. And so we should all be. The tone of the original article on the subject in the WSJ is strongly disapproving; here the tagline:

Critics say Goldman Sachs gives key trading tips only to its own traders and favored clients, hurting others who aren’t given the opportunity to profit from the information.

Apparently, GS analysts go into “huddles” with their salesguys, come up with short term stock ideas that may or may not totally chime with their formal ratings on the stocks. They may, in the case of Janus as cited in the article, sort of front-run ratings changes when the analyst says something like, “I like it more now” or “it may go up into numbers” or something. This stuff gets sent out in calls to high rolling punters like the big hedgies. According to a lot of bloggers (none of whom I note actually run any money, unlike Baruch) and those holier than thou twerps, the CFA brigade, this is a Bad Thing.

One can perform a reductio ad absurdiam on the more disapproving of the reactions: clearly Goldman Squid should be sending out every twinge every analyst feels on every stock under coverage all the time to everyone who pays GS any amount of money at all as well as those who don’t. This would mean everyone would be able to make lots of money all the time, in a completely fair and transparent way. Wouldn’t it.

Of course not. Actually, what GS is doing here really makes very little difference at all.

Baruch is a client of The Squid, and strictly tier 2. He can call the analysts, and they pick up and are civil and tell him stuff. But they rarely call him. No way does he get the “huddle” calls. But know what? He doesn’t actually mind because if he did, it probably wouldn’t help him very much. That stuff the GS flack was saying about it not being useful for all their clients, is, amazingly for a flack, true! I don’t want 5 day shelf-life trades; that’s the minimum length of my investment horizon (although my record is 15 minutes). It would annoy the crap out of me. Sure it is good to know when an analyst is about to change his mind, but it is more relevant for stocks I am in already, or thinking about taking a position in anyway. I would hurry up and get in, or stick around longer than I might have otherwise. I wouldn’t buy a stock only because I know some Squid hack was going to say it was suddenly good.

Another thing: it may shock you to know that GS analysts are not the best ones. Some are good and others are not so good. Their common strength is that they tend towards the more intelligent end of the spectrum, but note that this does not mean they are the most commercial, and will not necessarily make you more money. They do tend to talk lots to clients, and can tell you better than most what everyone else is thinking. This is often very useful. But for stock picking in the sectors Baruch looks at, for coming up with real money-making ideas, he finds someone like JPM does consistently better.

In fact some of the best analysts, with the strongest command of their briefs, with the best money-making ideas, are to be found in the smaller houses, ones where they have been able to carve out niches for themselves and analyse stuff the way they want to. Bulge bracket banks tend to force analysts to conform to house formats. MS forces their stockpickers to do this spectacularly crap “upside-, base-, and downside case” analysis which more often than not only goes to tell you that their stocks may go up, down or stay flat. A very expensive statement of the bleeding obvious.

Baruch knows his favoured stockpickers for each sector, subsector and big stock he looks at. If he had to pick the axe in each one, he honestly doesn’t think any of them would be from GS.

What he would get with GS “huddle” calls would be a large amount of noise by only averagely good stockpickers. It would likely distract more than it would help. I would feel smug getting the calls, knowing you don’t, and this alone would probably make it worthwhile in the minds of many of the punters. I would fancy I would be “in the flow”, and I would feel more confident about the positions I was taking. Again, managers would pay up just for this. It would be a struggle to prove that getting “huddle calls” actually made you more money, however.

It could also have the regrettable side effect of shoving you into the consensus, bein-pensant hedge-fund heavy positions which so spectacularly sucked in the back half of 2008. Just one last thought to leave you with. . .

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13 thoughts on “Defending the Squid”

  1. Could not agree more. Quite frankly the only reason to pay Goldman equity guys is to tap into their deal flow, but doubt IPO crumbs can move the needle at most shops.

    GS analysts came in dead last over past 52 weeks in the Barrons survey. Seems about right given my experience with them.

    But much ado about nothing.

    SJ

  2. Right or wrong doesn’t matter. How much right or wrong doesn’t matter.

    Material non-public information. Timing is also relevant here. The anlayst mis-lead the public and then disseminated the real opinion to favored insiders just days later. The material status of Janus did not change in 5 days.

    If you hold up a bank at gun point and you only get $100 from the teller, you cannot tell the Feds that you only got $100 so you are mostly innocent.

    1. Don’t be silly Chili. It’s nothing like holding up a bank. And it’s not material non-public information, it’s some bloke’s opinion. An analyst is not the effing pope.

      Timing? Sure, it might move the stock in the morning by about 2-3% if you’re lucky, but I’ve seen enough Goldmans upgrades greeted by no reaction, and/or something else happening that moves the stock down, so that gaming moves like this is a fools game. You will probably make more money shorting the morning pop and betting on the inevitable slow sell off later in the day. In the great scheme of things, who cares what the hell the Goldman guy thinks? Really, if some people want to pay up for getting some bloke’s opinion about a stock before anyone else and think it’ll make a difference to their investment returns, why not let them?

      Look, Goldmans are indeed evil, conspiratorial squid and are behind some dodgy and nefarious things. I read the Taibbi article and agreed with almost all of it. But I think of them as more like the KGB or CIA; smart by reputation, but in fact largely incompetent and all the more dangerous because of that. The thing is, they look good in comparison with their even-more-useless peers, and no-one publicises their failures, even though these are more common than their successes. They must probably be destroyed if our way of life is to continue (OK, I am only slightly joking), but not because of what we’re talking about here.

  3. Your counter all revolves around whether the information was valuable. That’s not the point. The point is it looks to me like not only did they share material information with a select group, they mislead the market just days before in order to make the information more valuable and increase the spead.

    Looks just like their $200 oil call last year at the peak.

    1. If any information, factual or opinion, received or disseminated to a select group before it becomes available to the “broader public” irks you so, why not fight all of the myriad subscription services while you’re at it?

      I almost kinda get your qualm-as-a-matter-of-principle approach, but as Baruch has said, its an impossible standard, practically speaking.

  4. You demand an impossible standard. Analysts aren’t machines, he could have changed his mind from one day to the next; happens all the time. And never forget, it’s still just some bloke telling you what he thinks about a stock. It’s not a massive new order, or someone knowing the numbers ahead of time, something that really IS material to the value of the company.

    Holding these guys to an impossible standard 1) hugely overstates their importance and 2) prevents them ultimately from performing their only useful function, which is helping GS clients sometimes to make money.

    Listen, you can’t make the market “fair” to everyone all at the same time. It stops working then. If no-one makes money, no-one participates. Civilisation falls. It penalises those who actually DO good fundamental work or find out things before other people.

  5. If this info was so worthless why did they reserve it only for best clients. These are supposed to be the smartest guys in the room. Sorry none of this adds up.

    1. This isn’t that hard: they “reserve” it for their best clients because their best clients trade the most. This encourages them to trade even more, and earns more in commission for GS.

      They tell everyone they are the smartest guys in the room, because it further encourages the punter to listen to their advice. That advice is rarely “don’t do any trades, you are fine”, it is “oh we may have changed our minds on XXXX, maybe you should trade it again for the 8th time this week, and don’t forget us when you place the order.”

  6. Ya I get that but if the information is so worthless and these are the best clients managing $100mm+ why would they be so dumb to even attend the huddle disseminating worthless information let alone trade on it.

    HOw do you get to be a “punter” and still be one of GS largest clients invited into the huddle. Sign me up.

  7. BTW don’t get me wrong. Love your blog. I just think you are on the wrong side of this one.

    1. Chili, we’re all punters. Citadel, you, me, and Dumbchuck Investment inc, even Goldmans, are all in the same boat, trying to make sense of a game where the cards are stacked against us. GS are only partly evil conspirators. Mostly they’re whores; just pay them enough money and they’ll pretend to love you.

      Remember, the information is sometimes valuable. Often it isn’t. But it’s useful just often enough to make people think it is worth it, even when empirically it really isn’t.

      Thanks for the kind words about the blog, and don’t worry, I exist in an environment where everone disagrees with everyone all the time. Getting cross about it would just be silly.

  8. Nice post. And thanks for the compliment to smaller, smarter firms.

    I see where Shorty is coming from here. When Goldman changes a rating, it’s most likely going to affect the stock, regardless of how good or bad the analyst is; so it’s material non-pi. It’s not only against the CFA code, it’s against the NASD and NYSE rules. Granted, it’s a little grey if he doesn’t actually say “I’m going to change my rating”. You may not like these rules, but they do help to keep the playing field level (which means protect against the extinction of financial markets).

    BTW, you need to brush up on your Latin. Reductio ad absurdum.

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