Wall Street’s Misallocation of Capital Is Worse Today than the Dot.com Era

By Pam Martens and Russ Martens: June 7, 2018 ~

Wall Street Bull Statue in Lower Manhattan

Wall Street Bull Statue in Lower Manhattan

Short memories are going to once again doom millions of stock market investors who are getting their advice from Wall Street’s minions of deeply conflicted analysts and brokers. This is a good time to reflect on the fact that when the dot.com bubble went bust from 2000 to 2002 it wiped 78 percent of the value off the Nasdaq stock index. In the midst of the crash, this is how Ron Chernow correctly described what was happening for New York Times’ readers on March 15, 2001:

“Let us be clear about the magnitude of the Nasdaq collapse. The tumble has been so steep and so bloody — close to $4 trillion in market value erased in one year —  that it amounts to nearly four times the carnage recorded in the October 1987 crash.”

Chernow characterized the Nasdaq stock market as a “lunatic control tower that directed most incoming planes to a bustling, congested airport known as the New Economy while another, depressed airport, the Old Economy, stagnated with empty runways. The market functioned as a vast, erratic mechanism for misallocating capital across America,” Chernow observed.

But it wasn’t some free market fluke that was directing investors’ capital to brand new businesses with no realistic plans for long-term survival. The “lunatic control tower” wasn’t a lunatic at all. The men behind the curtain in the control tower were making millions of dollars as crooked analysts at some of Wall Street’s largest investment banks. They were effectively pimps pushing lemon companies as hot IPOs in order to make themselves and their bosses rich while internally calling the companies dogs and crap in emails.

On April 28, 2003, the Securities and Exchange Commission, which has no criminal powers (a feature not a bug), settled the rigged research practices with 10 Wall Street banks for $875 million. Let that sink in for a moment: investors lost more than $4 trillion but Wall Street got off with a payment of $875 million. No one went to jail. Just two individual analysts were charged: Jack Grubman of Citigroup’s former Salomon Smith Barney unit and Merrill Lynch’s Henry Blodget. Both men were barred from future affiliation with a broker-dealer and paid fines that were a fraction of the bonuses they had collected.

The SEC did not stop these Wall Street firms from both bringing companies public and issuing buy recommendations on the same stocks. The SEC simply tinkered around the edges of this fatal conflict. For example, its settlement mandated that “Each firm will include a disclosure on the first page of each research report stating that it ‘does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.’ ”

The Wall Street banks that settled with the SEC in 2003 are not only still pumping out research reports on publicly traded companies but they are allowed by the SEC to trade these stocks (as well as their own company’s stock) in unregulated stock exchanges residing inside the bank and known as Dark Pools. Among the banks that were fined in 2003 by the SEC and operating Dark Pools today are: JPMorgan, Goldman Sachs, Citigroup, Morgan Stanley and Merrill Lynch.

Wall Street’s lunatic control tower seems to be operating on steroids today. Consider the stock of Apple versus the stock of Boeing. Apple went public on December 12, 1980, making it a 38-year old publicly traded company in December of this year. Boeing celebrated 100 years in business in 2016. Apple makes computers and phones, an industry in which there is a lot of competition. Boeing makes highly complex and sophisticated commercial jets (as well as defense, space and security systems) and has limited competition because of the massive costs and intellectual property that act as barriers to entering the manufacture of commercial jets.

The lunatic control tower, however, has allocated a market capitalization to Apple (the value of all of its shares outstanding) of $953.4 billion – just shy of a trillion dollars. Boeing on the other hand, with far greater barriers to entry and 64 additional years of business acumen, has a market cap of $216.46 billion – less than a quarter of Apple’s market value. (We’re not saying that Boeing is undervalued and is a buy at this price; just that there is a wild disconnect between the two stocks.)

Another striking example is the market cap of JPMorgan Chase versus Ford. JPMorgan Chase doesn’t manufacture anything other than financial products – for which there is essentially no barriers to entry. That is, hundreds of other investment banks, brokerage firms, insurance companies and mutual funds around the globe are doing the same thing. But somehow, JPMorgan Chase has achieved a market cap of $375.75 billion while Ford, which makes the automobiles that get us to and from work each day, has a market cap of a measly $47.70 billion. Even if you threw in General Motors, which has a market cap of $61.82 billion, you’re still looking at less than a third of JPMorgan Chase’s market value.

And here’s another weird anomaly. JPMorgan Chase’s stock price seems to defy not only gravity but mind-blowing reputational damage. The bank has pleaded guilty to three felony counts since 2014 and put on probation by the U.S. Justice Department and yet its stock has set multiple new highs this year. It should be noted that from peak to trough during the dot.com bust, JPMorgan Chase lost more than 70 percent of its value.

So exactly who is it that is putting out buy recommendations on the stock of Apple and JPMorgan Chase and levitating the stock price?

According to CNBC, Citigroup (former home to the infamous Jack Grubman) issued a buy rating on Apple on April 5 of this year. CNBC also reported in January that analyst Wamsi Mohan of Merrill Lynch (former home to Henry Blodget) has a buy rating on Apple and thinks the stock is going to a market cap of $1.1 trillion. Both Citigroup and Merrill Lynch are trading Apple in their dark pools. According to the latest data available from the self-regulator FINRA, in the week of May 14, 2018, Wall Street’s largest Dark Pools traded 7,081,415 shares of Apple in a total of 54,615 trades. In the same week, essentially the same Dark Pools traded 4,023,347 shares of JPMorgan Chase in a total of 22,979 trades. JPMorgan’s own Dark Pool, JPM-X, traded 300,115 shares of JPMorgan Chase’s own stock that week. See Wall Street Banks Are Trading in Their Own Company’s Stock: How Is This Legal?

Merrill Lynch’s Dark Pool, Instinct-X, is one of those trading in the stock of JPMorgan Chase. Merrill has 15,000 stockbrokers (advisers) who tend to follow the company’s buy recommendations like a moth to a flame. Merrill Lynch analyst, Erika Najarian, has a buy rating on the stock of JPMorgan Chase according to media reports.

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