January 16, 2006
Dow Jones Average: 10,960
S & P 500 Index: 1,288
Mad money
The most popular and influential financial show currently airing on TV
and radio is " Mad Money" with Jim Cramer. Twenty five years ago the
most powerful man on Wall Street was Joe Granville, an investment
newsletter writer. As his popularity grew Granville took his show on
the road, performing an act that was a mixture of finance and
vaudeville in front of boisterous audiences across the U.S. In the age
of cable TV and satellite radio, Jim Cramer can entertain and influence
a nationwide audience without leaving the studio.
The investing public has a strong desire for market prognosticators
who clarify with conviction the often confusing investment picture.
The clarity and certainty investors seek becomes reality when enough
people consistently follow the advice of one opinion leader. The
coordinated buying of a large group raises the price of a stock,
validating the bullish prediction made by the group leader. The
prophecies are self fulfilling as long as the group has additional
money to invest or can attract new members. This pattern thoroughly
played out in the late 1990's as millions flocked to the dot.com stocks
on the advice of that era's gurus, Abbey Joseph Cohen, Mary Meeker,
Henry Blodgett, and yes, Jim Cramer.
After the humiliation suffered by the dot.com bulls it is surprising
to see Jim Cramer wielding so much influence today. He claims to be
reformed and wiser, having learned from his mistakes in 1999-2000.
This time around he is qualifying his recommendations by telling his
viewers to commit only their high risk or "mad money" to his picks,
hence the name of his show. Judging by the relative performance of
certain stocks in 2005, it appears that there is a lot more mad money
coming into the market than any other type.
The challenge faced by all the market gurus is getting their loyal
followers out of favored stocks in a timely fashion. Investors who
have a need for a soothsayer with a crystal ball are not looking for
wishy-washy hold recommendations. They want clear cut buy or sell
advice. Market forecasters develop a cult like following when they
feed the public's desire for clear cut buy recommendations that
constitute an immediate call to action. Whereas buying enhances the
position of all followers, selling leads to a breakdown in the momentum
needed to sustain group cohesion. It is easy for investors to pile
into a stock, much harder to exit in a profitable way. Joe Granville
was exhorting his followers to stay one hundred percent in stocks right
up to the day that he came out with his famous sell everything call in
January 1981. The deluge of sell orders by his readers led to a halt
in trading for many leading stocks of the day, and when they did
finally open for trading the initial trade prices were 25 percent lower
than the previous close. We wonder if the same pattern will repeat if
and when Jim Cramer decides to issue sell recommendations on some of
the high-flyers his followers own.
Certain market environments are fertile ground for the development of
persuasive, opinion leaders. The prerequisites seem to be investor
appetite for risk and a diminishing number of obviously undervalued
stocks. These conditions are most prevalent near the end of a market
advance. In bearish market climates such as 2000-2002 there was no
memorable market guru and no need for one. The number of people who
wanted to take risks after the bubble collapsed was greatly diminished,
and those who did want to buy stocks had plenty of good choices.
Jim Cramer's influence has grown as investors have become bolder once
again and somewhat frustrated by the lack of movement in many widely
owned, large companies. It is difficult to say what his performance
record has been, since he issues a blizzard of buy and sell
recommendation on thousands of stocks. It does seem however that his
penchant for recommending expensive stocks with higher than average
valuation ratios, above average earnings growth, and strong stock price
momentum worked well in 2005. We do not subscribe to his style of
investing, but have to acknowledge his growing influence at this stage
of the market cycle. If you have never seen his show, and can tolerate
a rapid fire, maniacal speaker who may raise your blood pressure, you
may want to tune in to CNBC some evening and experience the man who
embodies the current market.
Current Strategy
The stock market held its ground in 2005 even though it had ample
reason to decline. Major averages such as the NASDAQ and S&P 500 index
were up by approximately 2 and 5 percent, respectively, on the year,
with a thin list of stocks accounting for most of the gain. There is
an old Wall Street adage that advises investors to avoid fighting
Federal Reserve Board policy. The Fed raised interest rates at every
meeting in 2005, taking the rate from less than two percent at the
beginning of the year to over four percent by year end 2005. Rising
rates usually pressure stock prices, but did not have much effect over
the past twelve months. Relatively strong corporate earnings, and a
rising U.S. Dollar that attracted foreigners to U.S. equities, most
likely offset the negative impact of higher interest rates.
We bought a number of new positions ( AIG, Checkpoint, Sanofi-Aventis,
Gannett, etc.) in 2005, although most of the gain we achieved was due
to further progress in stocks acquired in 2003 and 2004. Our strategy
of buying less popular stocks continues to work out over time. In most
cases the stocks we choose stabilize and then move higher. As they
gain in price, momentum investors such as Jim Cramer and his followers
climb on board pushing the price still higher. Momentum investors can
make money in certain market environments, but they definitely incur
more risk. We prefer the risk\reward relationship of starting low and
taking profits as others pile into the stock. We are currently seeing
opportunities in a number of stocks that have been ignored by the
momentum investors.
Interest rates on short term bonds moved up sharply last year. There
was surprisingly little movement in longer term paper which remained at
the 4.4 percent level. Short term treasuries now yield almost exactly
the same rate as ten year and thirty year bonds. We believe that the
Fed is nearing the end of its policy of increasing shorter term
interest rates. We would consider extending the maturity of our
clients' bond portfolios if longer term interest rates move up. For
the time being it seems safer and just as advantageous from a yield
perspective to stay with shorter term paper.
