Debunking the Cramer Myth

Jim Cramer delivers the dangerous message that investors can successfully pick winning stocks.

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The New York Times Magazine recently did a profile of Jim Cramer, titled “Jim Cramer Hits an All-Time High.” The author concludes that Cramer is a regular guy, who just happened to go to Harvard Law School, hit the jackpot managing a hedge fund, and accumulate “eight figures” in the bank.

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According to the article, from February 1987 until early 2001, Cramer’s hedge fund had a 24 percent return beating the S&P 500 index by almost 10 points. Jeremy Siegel, a distinguished author and professor of finance at the Wharton School, told the Times that Cramer had “a magical touch”. This impressive background has garnered a loyal following for Cramer’s Mad Money show, where he dispenses stock picking and market timing advice.

Here’s the problem: Cramer may have some appealing personal attributes, and his hyperkinetic personality may make him noticed in a crowd, but he has no better ability to pick stocks than someone throwing a dart at a board. His much hyped returns as a hedge fund trader are impressive, but they are unaudited and impossible to verify. Comparing his returns to the S&P 500 index is extremely misleading. It is likely his hedge fund took far more risk than this index. Without understanding that risk (for which there is no data) it is impossible to evaluate his returns.

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The Times article asserts that Cramer’s Action Alerts Plus portfolio has beaten the S&P 500 index in most years. This observation–even if true–is also misleading for the same reason. Assuming Cramer’s returns were stellar still doesn’t mean he has stock picking skill. Just because I flip ten heads in a row (a statistical possibility, albeit remote) doesn’t mean I am a skilled coin tosser. Many studies have demonstrated the absence of genuine stock picking skill even among the most sophisticated mutual fund managers. Cramer is unlikely to be the sole exception.

Efforts to study the stock picking advice dispensed with great confidence and flair by Cramer on his Mad Money show undercut his claims of stock picking expertise. An article in Barron’s concluded that Cramer’s stock picks typically underperform the market. Professor Siegel, who believes Cramer has the “magical touch”, has also had difficulty predicting the market. At the end of 2007, he predicted that "the economy will avoid a recession" in 2008. His crystal ball also told him that "the stock market will have another winning year in 2008" and that "financial stocks, which have plummeted 18 percent so far this year, will outperform the S&P 500 index next year [2008] as the credit crises fades." All of these predictions were wrong.

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A more accurate assessment of Cramer’s abilities was this observation by David Swensen, a distinguished author and the fund manager of Yale’s endowment, quoted in the Times article: “Mad Money delivers a very dangerous message—that individual investors can beat the market with momentum-driven, high-octane trading strategies. There are individuals who do beat the market, but their number is vanishingly small. Cramer is a master manipulator. He has absolutely no accountability. This is serious business; people’s retirements are at stake.”

Cramer may have many virtuous qualities. Stock picking expertise is not one of them.

Dan Solin is a senior vice president of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be released in September, 2011.