Monday, June 30, 2008

The Gods at Goldman Taketh Away, But Are They Right -- This Time?

Goldman Sachs research analysts are widely attributed, at least in part, to have been responsible for last weeks collapse in stock prices. As analysts are seemingly wont to do, they went into a crowded room and yelled sell and everybody did. They weren't alone in dissing stocks. As a result of the Fed's recent turnabout from worrying about recession and cutting rates to worrying more about inflation and potentially raising rates in the near term. Indeed, this shift came so swiftly that it was hard to catch in most hometown newspapers. We literally went from recession watch to inflation watch in a matter of days, as a result of upward revisions to GDP and clear signs that a recession is nowhere to be seen. The stronger-than-expected economic data would normally be seen as a good thing by the stock market, but in these days of skyrocketing oil and food prices, it was taken as giving the Fed enough breathing room to begin fighting inflation by hiking rates. Goldman analysts came out last week with sell signals on Citigroup and General Motors and downgraded the Brokerage and Industrial stocks. On Wednesday and Thursday, they lowered the proverbial boom on all these sectors in a curiously timed call on stocks groups that, for the most part, had already been hammered. Their only downgrade regarding a strong performing group was in the Industrial sector. Here they really couldn't find a lot wrong, but the rise in steel prices may put a drag on the group's earnings. Goldman has cachet, as they say. They have become the axe, the most powerful analysts on the street, and if they are saying sell or buy, the automatons of Wall Street follow, even if several other Wall Street analysts are calling things in the opposite direction, and even if Goldman's earlier predictions on almost all of these stocks were dead wrong. Goldman's axe comes from lots of success, but three stand out in particular: 1. They have been the most powerful investment banker for a decade or longer; 2. They have taken far fewer losses on subprime debt than their Wall Street brethren; indeed, they made billions by going short the subprime index; 3. Their oil analyst nearly a year ago called for oil to hit $100 per barrel, at a time when prices were not much more than half that price. Success breeds success, and success calls for more calls. Goldman in recent weeks has obliged those who have been anticipating their every word. First, their oil analyst suggested that oil prices could reach $200 per barrel. Immediately prices started lurching toward this new official Goldman target. Late last week they made sell recommendations on Citigroup and General Motors. Again their minions threw Citi and the General from the train. They don't like the Industrials because steel prices are going up, and , well, you know, these industrial bend a lot of steel. Finally, they think the big brokerages are in for more rough times ahead, reducing the group from buy to neutral. By my count on the days that they made these "bold" calls the markets were down a total of nearly 450 points, nearly 4%. But there is something wrong with this picture. Goldman is big and powerful and they know they can move just about any stock they want to pick on in these skittish markets. But to pick on a group of stocks that have already been mauled seemed like piling on to me. Something that smacks of mudslinging; after all, most of the companies they downgraded were in their own industy, if not direct competitors. It would be like in yesterday's Euro Cup soccer finals if one of the Spanish soccer players ran over and kicked Germany's Michael Balak after he was lying on the ground bleeding from catching a Spanish defender's head in his eye. Spain kicked the ball out of bounds like the true sportmen they are. Balak was sewn up on the sidelines in relative safety and returned to the match dazed but mobile. One just has the sneaking feeling that Goldman is not doing big investment banking work for Citi or any of the other brokers that they downgraded. I have not checked General Motors, but I would be surprised if Goldman was their lead investment banker, either. It is very curious to me that on October 1, 2007, even in the face of the subprime crisis, Goldman had good things to say about Citi and Merrill Lynch. Indeed, my recollection is that both had buy ratings for the year ahead. At the time Citigroup was trading at around $42, and Goldman had a year-ahead target price of $57. When Goldman cut their rating on Citigroup to a sell last week, Citi was selling near 18. In October of 2007, Merrill Lynch was trading at around $70, with a year-ahead target price of $94. When Goldman cut Merrill's rating last week to neutral, it was trading at $35. In September of 2007, with GM trading near $30 -- again after the subprime crisis was widely known -- Goldman had a buy rating and year-ahead price target of $37 for GM. Last week with the stock was selling for about $14, Goldman cut it to sell. The market gobbled up these bold calls by Goldman last week and kicked all of these stocks in the teeth. In my judgment, it is no act of courage to put out sell signals on beaten down stocks. The problem I have with Goldman's calls is that they were dead wrong six-nine months ago when they rated all of these stocks buys. Why should we be so pessimistic now when they are putting out sell signals or downgrading stocks that in most cases are nearly 50% far lower than they were when Goldman rated them buys? If history is any judge, we may be near the bottom in all of them.