When you’re buying stock, the best advice is to listen to respected stock market analysts. But be careful to look for objective investing information you can trust.
Almost immediately after the stock market plunged in October 2008, hundreds of thousands of loyal viewers tuned into Jim Cramer’s “Mad Money” (CNBC) for advice on where the market was headed and what they should be doing with their money. Cramer has gained considerable notoriety and a large following because of his entertaining presentation and super confident stock picks.
But how well do Cramer’s picks perform? Are you better off when you follow his advice? According to an article recently published on Barron’s website (Cramer’s Star Outshines His Stock Picks) there is no good evidence that Cramer’s picks outperform the market.
In fact, more than one study demonstrates that on the average Cramer’s recommendations under perform the market by most measures. From May to December of last year, for example, the market lost about 30%. According to different studies heeding Cramer’s Buys and Sells would have added another five percentage points to that loss.
Which is to say, following Cramer’s advice to the letter would have resulted in a greater loss than if you had just ignored it and put your money in an index fund.
One significant trend noticed in Cramer’s picks may explain the under performance of his recommendations. Along with a previous study done in 2007, the Barron’s article points out that Cramer’s bullish picks had actually risen about 4% in the two weeks ahead of his recommendation, while the bearish ones had dropped about 7%. In other words, the research team behind Cramer’s show may tend to default to momentum plays.
In other words, go with the stocks that are rising, dump those that are falling. In fact the study showed that when viewers followed this advice the day after broadcast they did better than waiting five days as Cramer himself usually recommends.
But over the longer term those recommendations turned out to be losers relative to the market – perhaps because of the longer term tendency of the market to correct for those moves that took place before the recommendation.
These findings has led some analysts to suggest an alternative strategy: betting against Cramer’s picks. For example, University of Dayton finance professor Carl Chen came to the conclusion that you could make over 25% in a month by betting against Cramer’s buy recommendations by using what are called short-term in-the-money puts.
So it’s possible that savvy investors can profit from Cramer’s recommendations after all. Just don’t expect to hear him crowing about it on his program.