Bulls, Bears, and Scapegoats on Wall Street.

Every bear market needs a scapegoat, and congressional fingers are currently pointing at stock analysts. These are the professionals at investment firms who scrutinize financial statements, make on-site visits to companies, interview managers, query competitors, and then publicly render their opinions (buy, sell, or hold) on individual stocks. Most analysts have a specialty: utilities, semiconductors, airlines. As a financial columnist, I have had hundreds of discussions with analysts, and, in general, have found them quite knowledgeable.

But don't take my word for it. In April, an extensive study of the performance of analysts was published in The Journal of Finance, a highly regarded publication for scholars. The authors--Brad Barber of the University of California at Davis, Reuven Lehavy and Brett Trueman of Berkeley, and Maureen McNichols of Stanford--looked at a database of 360,000 pieces of advice from 269 brokerage houses and 4,340 analysts, released between 1986 and 1996. They found that the analysts' favorite stocks returned an annual average of 18.8 percent, while those that the analysts denigrated returned an annual average of just 5.8 percent. The Standard & Poor's 500 stock-market benchmark over this period returned an average of 14.5 percent.

These results are exceptional. Rare is the mutual fund that can beat the S&P 500 by four points over ten years. In fact, the benchmark has beaten a majority of funds over the past two decades.

In an unpublished follow-up a month later, the authors found, again, that analysts produced spectacular results between 1997 and 1999. But the year 2000 was a debacle. The highly recommended stocks did poorly and the least-favored stocks did well. What happened? Dr. Barber calls the year "a mystery with a performance completely at odds with that of the previous 13 years.

Rep. Richard Baker (R-LA), chairman of the subcommittee with jurisdiction over the regulation of investment firms, seized on the 2000 results as the basis for a June 14 hearing on "whether securities analysts are providing unbiased research to investors." The unstated premise was that analysts were not objective--because they are torn by allegiances to the investment banking side of their firms (which earn big bucks by helping companies raise investment money), and by their own financial holdings.

During the bull market in tech stocks, many well-known Wall Street analysts, including Mary Meeker of Morgan Stanley Dean Witter and Henry Blodgett of Merrill Lynch, helped attract new business for their firms' investment bankers. No doubt about it. And Meeker, Blodgett and others were slow to change their optimistic recommendations for e-commerce companies like Priceline.com, so some observers wonder if their views were biased.

Peter Elkin of Fortune wrote that Ms. Meeker was "the single most powerful symbol of how Wall Street can lead investors astray," and that she "came to see herself not merely as an analyst but as a player--a power broker, a dealmaker, a force to be reckoned with." It is just this conflict--an erosion of the famous "Chinese Wall" separating the investment-banking side of a large Wall Street firm from the research side--which, in the eyes of critics, threatens the objectivity of analysts and the wealth of investors.