Friday 20 February 2015

Markets also need negative viewpoints

I normally quite like Bloomberg's articles, but find the following article not balanced enough:

"Anonymous Analysts Are Wreaking Havoc in the Asian Markets"

The headline is much too aggressive for my liking, the share price of two companies in SE Asia declining caused by negative reports is something else as Asian Markets turning into chaos.

The first paragraph:

"An anonymous researcher releases a report questioning the accounts of a publicly traded company. Investors catch wind of it and sell. The targeted firm denies the allegations, but by then the share-price damage is already done."

I have not yet met a single fraudulent company admitting its fraud at the first instance being confronted by a report. Since both honest and fraudulent companies will deny allegations, the denial itself contains therefore no news.

What could contain news is a detailed write-ups from companies in which they give a point-to-point rebuttal of all the allegations.

Even better, if companies had pre-empted events by providing a high degree of transparency to their shareholders. In Noble's case for instance there was unease for quite some time regarding the valuation of Yancoal, why had it not addressed that issue before? Valuing an asset at 56 times its market value is bound to raise some eyebrows.

Let's assume that short sellers are right in a particular case, then "the share-price damage is already done" is indeed true. But the damage is caused by unscrupulous managers and their financial engineers who have cooked the books, blown lots of hot air in the company, spread rumours etc. The short sellers have merely prevented more future damage (while in some cases profiting handsomely in the mean time, I admit).

Also, some of the allegations by so called short sellers or whistle blowers might need years to pan out. In 1999, financial analyst Harry Markopolos "informed the SEC that he believed it was legally and mathematically impossible to achieve the gains Madoff claimed to deliver". It took another nine years before the fraud was finally unravelled, lots of additional damage being done in those years.

A further comment from the Bloomberg article:

“No research should be anonymous,” said Jimmy Ho, president of the Society of Remisiers, Singapore’s biggest association of equity traders.

Whilst I agree that non-anonymous research would be better, I do have sympathy for the reasoning behind it:

Carson Block, the founder of Muddy Waters LLC, said in 2012 he stopped trying to bet against Chinese stocks after workers at a storage company he owns in Shanghai were harassed and unidentified “gangsters” came looking for him.

“Putting our name on the reports gave us more credibility but I understand why people see a need to be anonymous when publishing this kind of information because of the threats and the costs of extra protection,” Block said in an interview on Tuesday in New York.


...independent research reports can be beneficial for investors if they “weed out” companies that are bending accounting rules or engaging in fraudulent activity.

“I’m not concerned about the origins of the report, it’s whether the report is true, accurate and valid ultimately,” said Surtees, whose firm oversees about $50 billion. “Time will tell.”

Another comment by Mr. Ho:

“MAS should make sure analysts do not use their research for their own agenda.”

That also means that analysts (or brokers, bloggers or anyone spreading rumours to increase the share price of a certain company) who write positive reports for their own agenda (or the agenda of their company) should equally be punished. In that case government of all countries in the world should consider quickly building a few more jails for this purpose alone.

News on financial markets is rather biased, and all in a positive way for listed companies:
  • Managers have a real financial incentive (receiving wages but often also owning a stake in the company) to paint their companies as rosy as possible, they even hire PR companies for that purpose.
  • Brokers and the like receive their handsome fees through all kind of financial work for these companies (bringing them to the market, structuring deals, etc.), their research reports are often quite biased (just check how many "buy" reports there are versus "sell" reports). Even if brokers don't have a direct link to a company, they might be involved with one of the other companies of the majority shareholder.
  • Professionals like auditors and writers of independent reports too often have a bias towards the companies that pay them: "whose bread I eat, his song I sing".
  • Journalists are sometimes hesitant to post negative questions, their papers are sometimes biased towards companies that advertise (a recent example from the UK and the response containing the remarkable admission "All [media organisations] have their own self-serving agendas, both political and commercial"). 
  • Regulators should be on top of their game, but realistically they can't follow hundreds of companies and are not strong in particular fields (like valuations).

Despite all these shortcomings, I like the capital markets and am an active and passive (through external fund managers) participant for more than thirty years, both in listed and unlisted companies.

But giving the many biases, there is a clear and urgent need for views from "the other side", views that give critical analysis of companies, that question their accounts and their business models.

Therefore we have to be careful not to immediately jump on top of messengers of bad news.

The three cases mentioned in Bloomberg's article are:
  • Noble, in a report written by Iceberg Research, about which I wrote before;
  • Sound Global Ltd, in a report by Emerson;
  • Ozner Water, in a report by Glaucus.

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