Cramer's Star Outshines His Stock Picks - Barrons.com

I get more questions every year from students is on Jim Cramer than any other topic (well except "will this be on the test"). Most such questions come in two main flavors: "what do you think of Cramer" or "did you see Cramer talking about ....".

My stock answer is that while I think he is a really smart and hard working person, I have my reservations that anyone can consistently outperform the market and further most of the evidence suggests he can not.

My points were strengthened by Barrons this week:

Cramer's Star Outshines His Stock Picks - Barrons.com:

"The guy is a hardworking genius with a word of advice for everyone...many words of advice, actually. He dispenses thousands of Buy/Sell recommendations a year.....From May to December of last year....Cramer's Sells "made money" by outperforming the market on the downside by as much as five percentage points (depending on the holding period and benchmark). His Buys, however, lost up to 10 percentage points more than the market."

But the article went on to discuss much more. For example Cramer's "prepared buys and sell recommendations" did (SLIGHTLY) better than the lightning round picks. Which might be because of more rigorous analysis but the differences (especially on buys) makes any theory speculative.

Further, recent price movements appear to be a factor in what stocks get discussed and their recommendations. While I am usually not a fan of charts, this one may show why he does not do very well; his buy recommendations are usually for stocks that have gone recently (while his sells are for those that have gone down).

All in all a good article and definitely worth reading.

Two past FinanceProfessor blog articles on Cramer that are of interest:

1. A Barron's article showing his stock picking was not not much better back in 2007.
2. A tirade (which turned out quite prophetic) from 2007 saying that rising rates and falling real estate markets were going to cause a major problem with liquidity.

Unrelated to Cramer but one tidbit in the article that I am looking forward to using in class: EventVestor.com. Seems like an easy way to do event studies that could be used in several classes. Stay tuned on that!

Quote of the day

I did not do any of the weekend so we can get two today:

"I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle." -Winston Churchill

As quoted by Five Million Dots.

"It is common sense to take a method and try it.
If it fails, admit it frankly and try another.
But above all, try something.--FDR"

As quoted at Famous Quotes

An imperfect hedge: the case of Metallgesellschaft

If you have had me for MBA 610 you know in the "what can go wrong" with derivatives part of the class we usually discuss Metallgesellschaft. It is a classic case of when an imperfect hedge can really hurt you. I just stumbled upon this six minute explanation of what caused their problems that is very good.

SSRN-Costly External Finance, Corporate Investment, and the Subprime Mortgage Credit Crisis by Ran Duchin, Oguzhan Ozbas, Berk Sensoy

Durchin, Ozbas, and Sensoy look at Corporate Investment after the Subprime Mortgage Crisis and find much proof that the liquidity crisis is reducing capital spending.

SSRN-Costly External Finance, Corporate Investment, and the Subprime Mortgage Credit Crisis by Ran Duchin, Oguzhan Ozbas, Berk Sensoy:

"We study corporate investment in the wake of the sub prime mortgage credit crisis that began in summer 2007. The crisis represents an unexplored negative shock to the supply of credit for non-financial firms. We find that corporate investment declines significantly following the onset of the crisis. The decline is greatest for firms that have low cash reserves (or high net debt) or are financially constrained, i.e. more likely to face difficulties raising external capital. These results are robust to controls for industry- and firm-specific investment opportunities. We also find that 'excess' cash, as defined by previous work, is positively related to post-crisis investment, suggesting an important precautionary savings role for seemingly excess cash that has not been emphasized in the literature. Overall, our results suggest that an important channel for the effects of the sub prime crisis on the real economy is a tightened supply of credit for non-financial firms."

SSRN-The Equity Premium in 100 Textbooks by Pablo Fernandez

So which is it? In class this week we have been discussing CAPM and the question has some up a few times as to what is the market risk premium. I guess we are not the only ones who have some uncertainty on this issue. Pablo Fernandez shares with us his working paper on the issue.

SSRN-The Equity Premium in 100 Textbooks by Pablo Fernandez: "[I review] 100 finance and valuation textbooks published between 1979 and 2008 (Brealey, Myers, Copeland, Damodaran, Merton, Ross, Bruner, Bodie, Penman, Weston, Arzac...) and find that their recommendations regarding the equity premium range from 3% to 10%, and that several books use different equity premia in different pages.

Some confusion arises from not distinguishing among the four concepts that the word equity premium designates: Historical equity premium, Expected equity premium, Required equity premium and Implied equity premium."

A look in:

"... The average is 6.6%. Figure 1 is in line with an update of Welch (2000), who reports
that in December 2007, 90% of the professors used in their classrooms equity premiums between 4% and 8.5%, and with Fernandez (2008) who reports that in June 2008 finance professors in Spain used equity premiums between 3.5% and 10% (average 5.5%).

Figure 1 of the paper is very interesting:

After this he goes on to show what each author has used for the Risk Premium in different editions of the book.

So if you are not sure which premium you should use, I guess you are not alone. What do I use in class? Usually 6% but this follows a discussion of why risk premiums may change (transaction costs, increased/decreased risk aversion, more/less volatile economy).

Interesting work. Must have taken a while to go through 100 text books.

Financial Quote of the day

This one, which was right on, is by Susan Schmidt Bies (Fed Governor) speaking at a risk Management Conference in December of 2004. Seemingly many financial institutions did not get the message.

FRB: Speech, Olson—Qualitative aspects of risk management—December 7, 2004:

"Although the importance of the quantitative aspects of risk measurement may be quite apparent...the importance of the qualitative aspects may be less so. In practice, though, these qualitative aspects are no less important to the successful operation of a business.... Some qualitative factors--such as experience and judgment--affect what one does with model results. It is important that we not let models make the decisions, that we keep in mind that they are just tools, because in many cases it is management experience--aided by models to be sure--that helps to limit losses."

More evidence that correlations increase in bad times

In the typical "wow what great timing" yesterday as we were talking about correlations and diversification in class, SeekingAlpha ran the following article:

Opportunities in a High Correlation World -- Seeking Alpha:

"One of the most striking features of 2008 was the fact that correlations between most asset classes went up substantially: everything declined at the same time. One of the principal motivations behind diversifying is that all of your holdings will not decline at the same time. Declines in one class will be buffered by gains in another—or at least lesser losses in others. This effect has not provided much buffer in 2008."

The article provides some very interesting correlation matrices (uh, that sentence may never have been written before!) showing how correlations went way up as market prices went way down.

This is not the first time that has happened. In fact, it seems to be the norm. Butler and Joaquin (2001) showed the same thing. From their paper Are the Gains from International Portfolio Diversification Exaggerated? The Influence of Downside Risk in Bear Markets:

"The fundamental rationale for international portfolio diversification is that it expands the opportunities for gains from portfolio diversification beyond those that are available through domestic securities. However, if international stock market correlations are higher than normal in bear markets, then international diversification will fail to yie ld the promised gains just when they are needed most...."

This does not mean to not diversify, but rather to realize that diversification may not be enough and that in bad times, you have to expect all assets to more together more. This can help explain why puts (that move in opposite directions) and cash are in such demand during bear markets.

New feature: Financial Quote of the Day

I am sure I won't do one every day, but seems like something fun to do for a while, so here goes:

"It is wonderful how preposterously the affairs of the world are managed. We assemble parliaments and councils to have the benefit of collected wisdom, but we necessarily have, at the same time, the inconvenience of their collected passions, prejudices, and private interests: for regulating commerce as assembly of great men is the greatest fool on earth."

* Benjamin Franklin as quoted in Dean LeBaron's Book of Investment Quotations, page 119.

U.S. Plans to Curb Executive Pay for Bailout Recipients - NYTimes.com

U.S. Plans to Curb Executive Pay for Bailout Recipients - NYTimes.com:

"The Obama administration is expected to impose a cap of $500,000 for top executives at companies that receive large amounts of bailout money, according to people familiar with the plan.

Executives would also be prohibited from receiving any bonuses above their base pay, except for normal stock dividends. "

Well, this will definitely make Federal Bailout money less desirous.

The WSJ gives us another history lesson

I love history. I love seeing the similarities across the ages and then seeing them (Need a "for instance"? I am currently ristening to American Creations right now on the US constitutional convention of 1787. In it James Madison (who was 5 ft 4 and seemingly taller than his statue at JMU) argued that the way to solve problems with sectional thought in voting which would lead to excessive political swings was to make the republic larger. This is much the same argument many (including myself) have used to say that more hedge funds (not fewer) may (if there is sufficient diversity of opinions and strategies) reduce market volatility.)

Which is a very long-winded way of saying, the WSJ seems to be doing the same thing this week. After looking at what prolonged the Great Depression they turn their attention to looking back at past financial crises to see what we can learn:

Opinion: Expect a Prolonged Slump - WSJ.com by Carmen Reinhart and Kenneth Rogoff:

"...when one compares the U.S. crisis to serious financial crises in developed countries (e.g., Spain 1977, Norway 1987, Finland 1991, Sweden 1991, and Japan 1992), or even to banking crises in major emerging-market economies, the parallels are nothing short of stunning...

...Financial crises, even very deep ones, do not last forever....negative growth episodes typically subside in just under two years. If one accepts the NBER's judgment that the recession began in December 2007, then the U.S. economy should stop contracting toward the end of 2009. Of course, if one dates the start of the real recession from September 2008....

In the typical severe financial crisis, the real (inflation-adjusted) price of housing tends to decline 36%, with the duration of peak to trough lasting five to six years. Given that U.S. housing prices peaked at the end of 2005, this means that the bottom won't come before the end of 2010, with real housing prices falling perhaps another 8%-10% from current levels....

Perhaps the most stunning message from crisis history is the simply staggering rise in government debt most countries experience. Central government debt tends to rise over 85% in real terms during the first three years after a banking crisis. This would mean another $8 trillion or $9 trillion in the case of the U.S.

Interestingly, the main reason why debt explodes is not the much ballyhooed cost of bailing out the financial system, painful as that may be. Instead, the real culprit is the inevitable collapse of tax revenues that comes as countries sink into deep and prolonged recession. Aggressive countercyclical fiscal policies also play a role..."

They go on to briefly discuss differences this time around, but (to me at least) the similarities dominate.

NOTE: Past history rarely repeats itself exactly, but there are enough similarities to learn a great deal from it.

Sweden’s Fix for Banks - Nationalize Them - NYTimes.com

In class last Thursday the idea of temporarily nationalizing banks came up. I promised to show how it could work using Sweden's experience from the 1990s. Then I proceeded to forget to post it. So in a better-late- than-never moment, here is an article from the NY Times.

Sweden’s Fix for Banks - Nationalize Them - NYTimes.com:

"With Sweden’s banks effectively bankrupt in the early 1990s, a center-right government pulled off a rapid recovery that led to taxpayers making money in the long run.

Former government officials in Sweden, many of whom come from the market-oriented end of the political spectrum, say the only way to solve the crisis in the United States is for the government to be prepared to temporarily take full ownership of the banks.

Sweden placed its banks with troubled assets into a so-called bad bank, where they could be held and then sold over time when market and economic conditions improved. In the meantime, it used taxpayer money to provide enough capital to allow banks to resume normal lending."

As discussed last week, a key to this is making it temporary AND making sure there is a real downside (loss of jobs, no bonus, or loss of equity) for those who are taking the risks.

What caused the Depression? Opinion: Policies Prolonged Depression - WSJ.com

Here is hoping that we learned our lesson since the 1930s.

The WSJ ran a good op/ed piece by Harold L. Cole and Lee Ohanian describing how government policies helped create the Great Depression. As we ponder what the role of government should be in helping the economy to recover from the current recession, politicans could do much worse than to read this!

Opinion: Policies Prolonged Depression - WSJ.com:

"Why wasn't the Depression followed by a vigorous recovery...? It should have been. The economic fundamentals that drive all expansions were very favorable during the New Deal. Productivity grew very rapidly after 1933, the price level was stable, real interest rates were low, and liquidity was plentiful. We have calculated on the basis of just productivity growth that employment and investment should have been back to normal levels by 1936....

So what stopped a blockbuster recovery from ever starting? The New Deal. Some New Deal policies certainly benefited the economy by establishing a basic social safety net through Social Security and unemployment benefits, and by stabilizing the financial system through deposit insurance and the Securities Exchange Commission. But others violated the most basic economic principles ... choked off powerful recovery forces.....The most damaging policies were those at the heart of the recovery plan, including The National Industrial Recovery Act (NIRA)....covered over 500 industries.... created a code of "fair competition" which spelled out what producers could and could not do, and which were designed to eliminate "excessive competition" that FDR believed to be the source of the Depression.

These codes distorted the economy by artificially raising wages and prices, restricting output, and reducing productive capacity by placing quotas on industry investment in new plants and equipment....Our research indicates that New Deal labor and industrial policies prolonged the Depression by seven years."

And it should be noted that this was not a knee jerk reaction to the current recession; Cole and Ohanian published their famous work which is the basis for for the current WSJ piece in the Journal of Political Economy in 2004.

Not coincidentally I am finishing up The Forgotten Man by Amity Shlaes who largely comes to the same conclusion and paints a picture of FDR as a really bad economist to say the least.

The Future of Securities Regulation by Luigi Zingales

Luigi Zingales has been in the news a bunch lately. He has testified to Congress, been on NPR, in Forbes, in The Economist, and the Wall Street Journal to name just a few (and these have all been since September!!!)

Which is to say when Luigi Zingales speaks (or writes) on the Future of Securities Regulation it makes sense to take note.

(On the paper that follows he only allows two paragraphs quotes so the review will be short, but by all means read the whole thing.)

SSRN-The Future of Securities Regulation by Luigi Zingales:

"....I propose a series of reforms that center around corporate governance, while shifting the focus from the protection of unsophisticated investors in the purchasing of new securities issues to the investment in mutual funds, pension funds, and other forms of asset management....three main areas of intervention.

1. First, a reform of corporate governance aimed at empowering institutional investors to nominate their own directors to the board....a new Glass-Steagall Act, which...will separate mutual fund management from investment and commercial banking...
2. The second goal should be the protection of unsophisticated individuals with regard to their investments. The minimum this protection entails is enhanced disclosure....
3. The third goal should be that of reducing the regulatory gap between public markets and private markets. The recent trend of migration...suggests that this differential is excessive. This migration should be stopped not only by deregulating the public market, but also by introducing some disclosure standards in the private one."

(note the numbers (1,2,3) were added to help the reader and are not in the actual paper).

Good stuff! I highly recommended reading it all!

An I^3 Paper!(Interesting, Important, and Informative)


BTW: even if you are not interested in regulation, the figures at the back of the paper are excellent and could/should be included in many classes from Investments to Macroeconomics, Money and Banking, Financial Institutions, and even Corporate Finance.

Cite: Zingales, Luigi ,The Future of Securities Regulation(January 29, 2009). Chicago Booth School of Business Research Paper No. 08-27; FEEM Working Paper No. 7.2009. Available at SSRN: http://ssrn.com/abstract=1319648

The Copyright I guess is to Zingales himself, but I could not find it on the paper but he asked the copyright be mentioned. I would say it is his, but I will check and edit this when I know.

SSRN-The January Effect - A New Piece for an Old Puzzle by Jason Fink, Kristin Fink, Jonathan Godbey

You probably have all heard of the January effect. It is the historical fact that stocks have done better in January than in other months. That much all researchers agree on.

Why? That is a very good question. Some seems to be taxes, some size, but now Fink, Fink, and Godbey find that the age of the firm also matters. Specifically young firms out perform old firms in January even after controlling for size and other factors.

SSRN-The January Effect - A New Piece for an Old Puzzle by Jason Fink, Kristin Fink, Jonathan Godbey:

"For decades the finance profession has noticed the tendency of equity prices, most noticeably for small stocks, to rise in value in the month of January. The small stock January effect appears to have been significant over the last thirty five years. However, we demonstrate that even after controlling for both the size of the firm and systematic factors, young firms experience significant and abnormally positive January returns. This age effect has several possible sources, including firm level information uncertainty in January or increased investor demand related to young firms."

Now I can say this about the paper since the authors are friends of mine and if you can't pick on friends who can you pick on? Uh, Good timing.

How so? Well the paper came out in October. I waited with the intent of using in in January as soon as the market turned up. So what happens? I will let CNN tell you:

From CNNMoney.com:

" It was the worst January ever for the Dow industrials and S&P 500, according to Stock Trader's Almanac data.

The Dow lost 8.8% and the S&P 500 lost 8.6% in the month.

The Nasdaq's loss of 6.4% was eclipsed by last January's loss of 9.9%. That 2008 loss was the worst in the tech average's history, going back to its inception in 1971."

Oh well. Maybe next year. OR (and this is stated entirely without proof since as far as I know there is not a "new firm" index), given the average age of firms in the NASDAQ is less than that of the DOW and S&P 500, maybe it supports the paper even more.