Mad Money – January 2006

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 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 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.

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