Wednesday, June 10, 2009

The Official End to the Bear Market Rally

Mad Money

Jim Grant of Grant's Interest Rate Observer did a spot on CNBC this morning in which he discussed the fact that apparently 15 out of 16 primary government bond dealers are under the impression that the Fed will not move on interest rates before the end of the year. Grant hinted that the magnitude of unanimity often suggests that the consensus is bound to be wrong when all is said and done. Broad based agreement of this sort is what I would call a contrary indicator. When sentiment is so decidedly flowing in one direction it is often a signal that the tide is about to turn. As many stock market investors know, the time to get out of a position is often when everyone has jumped on the same bandwagon.

Now, I don't have a particular view on whether or not the Fed will raise interest rates by the end of the year. However, the contrarian in me is always looking for reasons to go against popular sentiment. Many of the most successful value investors have a contrarian bent. The strategy of being greedy when others are fearful is a universal contrarian mantra that entails looking for opportunities to go against the investing herd.

A quote from one of my favorite investors, Howard Marks of Oaktree Capital, encapsulates this point of view perfectly:

I’d define skepticism as not believing what you’re told or what “everyone” considers true. In my opinion, it’s one of the most important requirements for successful investing. If you believe the story everyone else believes, you’ll do what they do. Usually you’ll buy at high prices and sell at lows. You’ll fall for tales of the “silver bullet” capable of delivering high returns without risk. You’ll buy what’s been doing well and sell what’s been doing poorly. And you’ll suffer losses in crashes and miss out when things recover from bottoms. In other words, you’ll be a conformist, not a maverick; a follower, not a contrarian.”

Have you been getting technology stock tips from your cab driver? Then it is probably time to sell any high fliers in your portfolio. Have you heard about all the great condo flipping opportunities there are from the guy who parks your car? Then it is likely time to postpone buying that condo in South Beach you have always wanted. Has your hairdresser been extolling the virtues of gold and hard assets as potential offsets of inflation? Then it might be prudent to lighten up on shares of GLD. Not to be facetious, but by the time non-professional investors have picked up on market trends it is very likely that they are close to running their course.

In the mass media today the ultimate contrary indicators are the opinions of the much maligned Jim Cramer. For those of you who have not had the unique pleasure of being exposed to Cramer, he hosts a show on CNBC called Mad Money. It is basically the Sesame Street of investing for adults, complete with funny sounds, props, and a cartoon-like character (Cramer himself). Would you accept investment advice from Oscar the Grouch or Cookie Monster? No? Then you probably should not listen to Cramer either. The problem is that millions of people tune into his show each week (apparently close to 380,000 a day) and get what I would call capricious and short-term focused advice. Cramer’s stock selection criteria and strategy are anathema to value investors. Accordingly, the poor man is the butt of many jokes on the buy side (hedge funds). In fact, if you ever are within an earshot of a fund manager who learns that Cramer has recommended one of his or her positions, the likely response from the manager will be something on the order of: “Cramer likes it? I better start looking to sell.”

If you are interested in analyzing Cramer’s stock picking prowess you can read this piece entitled “Shorting Cramer” in Barron’s from 2007 that suggests his picks underperformed the S&P meaningfully over the period reviewed by the magazine. Or you can review this recent study entitled “Investing in Mad Money” by Northeastern professors of finance Bolster and Trahan (who obviously have WAY too much time on their hands) which concludes:

The full period results provide little compelling information that Cramer’s recommendations are extraordinarily good or unusually bad…Thus, we find inconsistent evidence of Cramer’s ability to add value through security selection.”

So, why am I picking on Cramer now, you ask? Doesn’t he receive enough criticism as it is? In all honesty I have nothing against the man. I actually feel a little bit sorry for him. But I sure wish he would stop making grandiose proclamations about the market. Case in point, here are some excerpts from an article entitled “The Bear Stearns Bull” published in New York Magazine on March 21st, 2008, right after Bear Stearns failed and the S&P was over 1300:

“We’ve been through dozens of false bottoms, but this time, with the Fed and Treasury basically saying they will do anything it takes to save the system, you finally have a floor that can hold the weight of America’s savings. Mind you, I don’t think we’ll have a meaningful rally up from the current levels until we’re closer to the election (the uncertainty of an election almost always means we go nowhere). But now, at least, I feel the bear has been tamed, and the worst of the clawing is over.”

Sorry Jim. That bear continued to claw away at the market and brought it all the way down to 666 less than a year later.

“But the JPMorgan-Bear deal eliminates the prospect of the mortgage crisis’s taking down any other institutions, because JPMorgan went up the equivalent of $15 billion right after it pants’d the Fed and Treasury.”

Wrong again Jimmy boy. Ever hear of Lehman Brothers? Well, the mortgage crisis brought that down and probably would have done the same thing to Citibank (C) and Bank of America (BAC) too if the government had not stepped in again.

“I don’t know a soul who’s predicting an immediate end to the national decline in home prices. But I think that the upticks in the stock market, particularly in banks and home builders, are foretelling the truth: The worst will soon be over.”

Unfortunately housing has continued to drop for more than a year since then and we are still not even sure the worst is over.

Don’t get me wrong. A lot of people have underestimated this crisis. Many people much smarter than me invested in stocks after Bear collapsed and even after Lehman went down in anticipation that the declines in value were just temporary. In addition, within my own portfolio I have not navigated these treacherous waters as well as I would have hoped. It is a lot harder to be a contrarian and keep your emotions in check when it feels like the world is ending. But the difference between Cramer and I is that I am not presumptuous enough to think that I know what the bottom of a market looks like and I certainly would never suggest that anyone buy or sell a stock based on my prescience.

Unfortunately, he is at it again in an article entitled “Thank Bernanke” published on June 5th in New York Magazine.

“The soft-spoken academic who has toiled in the shadows of his legendarily self-promoting predecessor, Alan Greenspan, will be known as the man who averted the Great Depression Two, a sequel that could have eliminated the United States as a world financial superpower and reduced us to this century’s Britain.”

Any investor who is bullish at all about the world economy and stock markets should shudder when they read that Cramer has given the all clear signal. If his ability to analyze the depth of the crisis in March of 2008 is any indication, we may be very far from a bottom now.

“He (Bernanke) went on 60 Minutes. We may not have known it at the time (unless you’re a financial type, his appearance wasn’t exactly riveting), but when we look back at the beginning of the new bull market of 2009, the one that has taken prices up 30 percent from their bottom, we will discover that Monday morning, March 16, the day after Bernanke sat down and talked to us straight about the jam we were in, was a seminal day.”

Poor Ben Bernanke. Not only is he stuck with rising Treasury yields despite his attempts to keep them down, but now he has been jinxed by Cramer. Being endorsed by Cramer is kind of like being on the cover of the EA Sports John Madden football video game. The Madden curse, as it is widely known, came about as a result of the player on the cover consistently either getting injured or having a terrible season after being selected to grace the cover. For the sake of all investors let us hope that Cramer’s magical ability to be completely wrong has dissipated and his recent call is not the ultimate contrary indicator that the world economy is in for substantially more pain.

Mad Money

Sorry, I couldn’t resist. If you haven’t seen this, it is a clip of Cramer on the Daily Show. Anyone who likes John Stewart will love watching him skewer Cramer.

The Daily Show With Jon StewartMon - Thurs 11p / 10c
Jim Cramer Pt. 2
Daily Show
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Political HumorNewt Gingrich Unedited Interview