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 celebrity and a large following because of his entertaining presentation and super confident stock picks.
But does Cramer’s advice actually work? 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 do not perform as well as the market by most measures. From May to December of last year, for example, the market lost a whopping 30%. According to different studies following Cramer’s Buys and Sells would have resulted in an additional 5% loss.
In other words, following Cramer’s advice to the letter would have resulted in a bigger 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 advice. 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%. This suggests the research team behind Cramer’s show may tend to default to momentum plays.
This seems like a reasonable strategy - go with the stocks that are rising, dump those that are falling. In fact the study showed that when viewers acted on this advice the day after broadcast they did better than if they waited the five days that Cramer himself usually recommends.
But over the longer term those recommendations turned out to be losers relative to the market - perhaps because the market tends to even things out, correcting 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 picks after all. Just don’t expect to hear him bragging about it on his program.