Reports of the death of the equity culture, it seems, were greatly exaggerated in the aftermath of the crisis that convulsed Wall Street last fall. True, the financial landscape has been indelibly altered — venerable firms such as Bear, Stearns & Co. and Lehman Brothers are gone, and others such as Merrill Lynch & Co. and Wachovia Securities have been absorbed by former rivals — but investor appetite for risk has returned much sooner than many market observers expected. The Dow Jones industrial average closed September with its best quarterly showing in nearly 11 years (and less than 300 points from the psychologically important 10,000 mark), and the Standard & Poor’s 500 index rose 56.3 percent from its March low, to 1,057.08.
The sudden rekindling of investor interest comes at a challenging time for many equity research departments. Beginning last fall and throughout the spring, some firms were struggling to integrate operations in the wake of hastily arranged mergers, others were coping with layoffs as banks slashed costs to boost bottom lines decimated by credit-related losses, and the market was experiencing unprecedented turbulence amid one of the worst sell-offs in decades. Thousands of confused, anxious clients had questions.
“When a client is suffering and feeling the pain of the market, they want help and they want to talk,” says Stuart Linde, who became global head of equity research at Barclays Capital last fall after its parent company acquired the North American assets of Lehman Brothers Holdings, where Linde had been director of U.S. equity research. “When the market contracts and there is tremendous volatility, the natural instinct is to hide, but we were very visible at a time of market dislocation and even more so after the merger,” he adds.
Stephen Haggerty, head of Americas equity research at BofA Merrill Lynch Research, concurs. “Portfolio managers are just as flustered by volatility in the marketplace as everyone else, and they want to be able to talk to senior, tenured analysts,” he says.
Which firms are home to the analysts whom investors most value for their insight and guidance? To find out, Institutional Investor polled more than 3,000 research directors, portfolio managers and other investment professionals at more than 890 buy-side firms, including 87 of the 100 biggest U.S. equity managers. In the tightest finish in seven years, Barclays Capital holds on to the top spot on the All-America Research Team, our annual ranking of the nation’s top equity analysts as determined by the world’s leading money managers. BarCap wins 46 total team positions, only two more than second-place J.P. Morgan. The last time the top two firms finished so closely was in 2002, when Citigroup/Salomon Smith Barney bested Lehman Brothers by one position. One year later, Lehman advanced to No. 1 and stayed there until fallout from the mortgage crisis forced the firm into bankruptcy last year.
Although J.P. Morgan remains in second place, the firm adds six team positions, for a total of 44, whereas BarCap picks up only one position. Repeating in third place is BofA Merrill Lynch Research, which also adds one position, for a total of 37.
The biggest gains can be found at UBS and Credit Suisse. UBS picks up seven positions, for a total of 33, and moves up a notch to fourth place overall. Credit Suisse is the real stunner, gaining 14 positions, for a total of 31; the firm jumps from seventh place to fifth. Sanford C. Bernstein & Co., the highest-ranked independent research firm, holds steady in sixth place but adds five positions, for a total of 28.
Equity research directors, who spent much of the past year cutting staff and reducing stock coverage, now find themselves looking to expand again as investor interest rises. Linde says all but one of his 74 equity analysts from Lehman made the leap to BarCap, but the number of companies covered was reined in, from 1,000 a year ago to about 950 now, although he plans to increase that figure to 1,100 by next year.
Thomas Schmidt, head of Americas equity research at J.P. Morgan, says his firm lost five analysts over the past year — from 60 following the firm’s government-backed acquisition of Bear Stearns Cos. in May 2008 to 55 — and realigned its stock coverage to make the most efficient use of available resources. “If a sector, as a stand-alone, did not have enough revenue or client interest to support it, we consolidated it into a related sector,” Schmidt explains. The firm’s analysts now track about 1,200 U.S. companies, and Schmidt expects that number to grow by 5 to 10 percent over the next 12 to 18 months.
Haggerty was given the task of integrating two equity research operations following Bank of America Corp.’s acquisition of Merrill Lynch, which was completed in January. “We took two very talented research departments and came out with one, so as you can imagine, there were some tough decisions that had to be made — but the strength of the department has improved,” he says. Although Haggerty declines to cite specific figures, he says the bank boasts “45 to 50 senior analysts” who follow 800 to 900 stocks, and he plans to expand that coverage universe over the next few months.
UBS experienced more turbulence than most, largely because of cost-cutting associated with the Swiss bank’s nearly $38 billion in subprime-mortgage-related write-downs through year-end 2008. The firm lost 15 U.S. equity research analysts — one quarter of its department — but has since hired replacements, according to David Bleustein, head of U.S. equity research. “There was a window earlier in the year when we had some analysts leave to go to competitors or boutiques, but as the year went on, we were able to hire back some extraordinary talent,” Bleustein says. UBS now has more than 60 researchers in the U.S. and is looking to recruit one senior analyst and a couple of associate analysts.
Sanford C. Bernstein responded to the crisis differently than bulge-bracket firms. “Our strategy has been to reinvest in the downturn and grow,” explains David Barnard, director of U.S. research. The firm employs four more analysts than it did one year ago, for a total of 30 — all but two of whom are cited in this year’s ranking. Bernstein analysts track about 225 companies, and Barnard says that number will increase by at least 10 percent by year-end 2010.
Upheaval in the markets — and in the various research departments — has given some analysts an opportunity to shine as never before. Thirteen of the top-ranked researchers in this year’s survey appear in the winner’s circle for the first time. Profiles of all of this year’s winners can be found by clicking on the Leading Analysts tab of the 2009 All-America Research Team Rankings.
Vishal Shah of Barclays Capital is the first winner in the newly added Alternative Energy sector. Governments around the world have been promoting the use of alternative energy sources as a way to reduce their dependence on fossil fuels, and Shah believes this bodes well for the companies he covers. “Some of these technologies are now competitive or near competitive with traditional energy sources, so there is a case you can make for scalable growth,” he says. However, the ability of these firms to acquire financing, Shah adds, “will determine the winners and losers in the space.”
Another sector garnering a lot of government attention is Health Care Technology & Distribution. Robert Willoughby of BofA Merrill makes his first appearance at No. 1 at a time when the Obama administration has made health care reform its top domestic priority. Willoughby says the fear of government intervention prompted many investors to flee the sector, but in so doing they overlooked a key aspect of the market: companies that will benefit from any reform that extends medical coverage to the nation’s 46 million uninsured. Health care reform legislation “may not be good for big pharmaceutical companies, but the incremental utilization of drugs, laboratory services — and increased need for low-end supplies such as rubber gloves — is generally good news for my world,” Willoughby says.
Ali Dibadj’s world is looking good too. The Sanford C. Bernstein analyst is on top for the first time in Cosmetics, Household & Personal Care Products, a sector that many market observers consider virtually recession-proof: Consumers will continue to buy soap, shampoo, laundry detergent and other products even in a down economy. But that doesn’t mean the companies Dibadj covers haven’t felt the pinch, especially those outfits with designer offerings. “Even the most basic personal or cosmetic products we use now have some sort of bells and whistles, and consumers are saying in this recessionary environment, ‘We can do without,’” he says, noting that many shoppers have shifted away from brand-name products to less expensive private labels. As the economy improves, Dibadj says, about half of those consumers will go back to buying the higher-priced alternatives.
Aerospace & Defense Electronics is a sector that also appears to be insulated from the effects of the recession, but looks are deceiving. “It’s a very cyclical business and typically lags the macroeconomic situation by up to a year or more, because it’s difficult to change airplane production rates,” explains J.P. Morgan’s Joseph Nadol, who rules the roost for the first time. He predicts that as the government’s defense budget flattens out, after ten years of growth, and troops are pulled out of Iraq, the sector will see a modest decline.
“As you get out into 2011 and 2012, there will be some ups and downs, but for the most part the defense sector will see a flattish earnings picture,” he says.
Christopher Senyek of ISI Group makes his first appearance at No. 1 in Accounting & Tax Policy, a sector that investors and analysts alike have been monitoring closely. Earlier this year, Senyek accurately predicted that the Financial Accounting Standards Board would relax its rules on mark-to-market accounting, which many economists and market observers believe exacerbated the financial crisis. The rules, which had required banks to use current fair market value even for assets they had no intention of selling — thus forcing banks to hike their capitalization levels after market routs, when raising capital can be extremely difficult — were amended in April to allow exceptions for items that banks intend to hold to term.
Mark-to-market is hardly the sector’s only controversy. “Banks rely heavily on historical loan-loss reserving, and over the next 12 to 18 months, there will be substantive changes that will result in banks holding higher reserves,” Senyek predicts. “We will be closely following that in terms of what it means for earnings and capital levels,” he adds.
Those issues are on the minds of many investors, who wonder if the current rally is sustainable or if the beleaguered financial services sectors will stumble again and drag the broad market down with them, as was the case last year. It’s too soon to tell, but money managers seeking guidance from the industry’s best and brightest analysts need look no further than the members of the 2009 All-America Research Team.
