Is There Less Information in the Stock Market?

The most important principle governing the stock market is disclosure of information. Information is the lifeblood of the financial markets. Investing is basically a bet on the future, and you can't predict the future value of an investment without plenty of information. Leave investors in the dark, and they'll steer clear of stocks, bonds and other financial investments.

The amount of information in the market seems to be decreasing. For example, consider:

Earnings Blowouts. Many large companies are reporting third quarter earnings that significantly exceed previously announced analyst estimates. Caterpillar, Sallie Mae, PNC Financial, Amazon, American Express, Capitol One, Morgan Stanley, and Goldman Sachs are examples. Caterpillar stands out. Analysts predicted that it would earn 6 cents a share, and it reported 64 cents. This is flat out cognitive dissonance. One wonders if there are a lot of inattentive, dumb, undercaffeinated and/or too-busy-texting-for-a-date analysts covering Caterpillar, or if the company gave some seriously inaccurate guidance. Or maybe it was all of the foregoing, with the Major League Baseball playoffs diverting everyone's attention. Of course, there is a game of sorts with earnings projections: companies like it when analysts underestimate their earnings, so they can pop their stock with a seemingly glowing earnings report. And investors aren't taking it lying down. Whisper numbers seem to have returned, putting companies under pressure not to beat just the published analyst estimates, but the "real" wink-wink estimates that the market actually expects. Goldman Sachs may have beat expectations one time too many this past summer when it reported unexpectedly glowing second quarter results. When it reported unexpectedly glowing third quarter results, the market seemed disappointed, evidently because Goldman didn't smack the heck out of the whisper numbers.

More than three-quarters of S&P 500 companies that have reported earnings thus far have exceeded analyst estimates. By itself, that's not unusual, because many companies provide guidance that tends toward the conservative side. But if the disparities between Street estimates and company results widens enough, investors will soon realize that they're not really getting much useful information from analysts. The market and the Street will both suffer if investors lose faith.

Dark Pools and High Speed Trading. A growing amount of stock trading takes place in ways that ordinary investors can't see. Significant volumes of stock trade in so-called alternative trading systems that are available to the big boys on the Street, but not ordinary, long term investors (hereinafter referred to as "sheep"). Also, a lot of trading takes place on a computerized basis, so fast that the sheep may not be able to see the best prices before a computer snaps them up. The sheep get only those prices that the smart money, bolstered by monster amounts of computing capacity, knows to be too lousy to trade with. As more and more trading becomes invisible, sheep (i.e., investor) confidence will lag.

Bank Financial Statements. Earlier this year, the banking industry applied extreme political pressure on the accounting authorities (the FASB) to ease up on interpretations of rules requiring so-called mark-to-market and fair value accounting of dodgy financial assets at the heart of the mortgage mess and credit crunch. Since then, the banks seem to have booked rosy valuations of these assets and kept them, along with the risk of loss they entail. Keeping the aromatic assets isn't exactly the obvious thing to do, with the real estate market mostly continuing to fall. But a bank doesn't have to book a loss by holding them, while it would if it sold them. Investors had better hope that what they don't know won't hurt them.

Insider Trading. The recently announced $25 million plus insider trading case against Galleon Management LP and a potpourri of individuals would, if its allegations prove true, signal that insider trading remains endemic. Although a major government crackdown 20 odd years ago sent some high level Wall Streeters to prison, memories apparently are short, especially when there's money to be made. And inside information is more valuable than gold. It gives you an advantage over the sheep, who will get yesterday's price while you angle for tomorrow's better price. There will be insider trading as long as there is inside information. But the pros on the Street might again be increasingly emboldened, too often taking undue advantage of their privileged positions.

The regulators may be able to do some things to lessen the growing murkiness. But the movers and shakers on the Street can do more, much more. Short term considerations tend to favor opacity over transparency, slaughtering the sheep over giving them a fair shake. But, ultimately, financial markets need outside sources of capital, which means they need investor money. Investors, in turn, don't want to buy a pig in a poke. Large numbers of long term investors have been sitting out the current, all-news-is-good-news rally, because they simply don't believe that things can suddenly turn from really bad to really good. The growing murkiness on the Street may well make them sit tighter.