Cramer's Now a Market Timer?

by: Jason Schwarz

Proven investment strategies get thrown out the window during extreme market highs and extreme market lows. For example, during the tech bubble analysts believed p/e ratios no longer were a viable metric of stock valuation. They threw out this historically proven method in hopes of rationalizing a new era where earnings didn’t matter. That strategic change didn’t end up very well. Investors who abandoned the p/e ratio got pummeled when the tech bubble burst and eight years later the Nasdaq is still not even half of what it once was. Now we are living in the opposite extreme but the same tendency to throw out timeless investment principles is happening again.

This time it’s coming at us on national television by none other than Jim Cramer. In a new commercial, he claims that the old days of buy and hold are over. He feels the only way to survive this market is to become a market timer. For most, a switch to this philosophy is akin to the kiss of death.

Investors with the ability to live through volatility without changing their investment thought process are the ones who will recover their losses and profit in the end. Most people have a terrible time not selling their stocks at a loss, they can’t average down, they can’t handle short term pain even if it would result in long term gain. The problem with market timing is that you typically get out at the low and get back in at the high.

Empirical evidence shows that "80 percent to 90 percent of investment returns have occurred in spurts that amount to 2 percent to 7 percent of the total length of time of the holding period," says John Spears, a partner at Tweedy Browne & Co. "The rest of the time, stocks' returns have been small. You have to be in to win." Have we entered a new era of investing where this past statistic no longer matters?

From 1937 to 1941, the market fell 60%. Since then, the two worst bear markets were 1974-1975 and 2000 to 2002. Both were off about 48%. At the intraday low last Friday, the S&P was off 50% from its peak last October. What kind of recovery can we expect? I think it’s safe to say that historical trends will repeat themselves as they always do. $1000 invested in the S&P 500 in 1977 left untouched would have grown to $38,730 in the 30-year period ending December 31, 2007.

However, if you would have been out of the market for the top 20 performance months out of that 360 month period you would have only gained $6,483; costing you $32,247! Also consider a $1,000 investment made in 1998 that was left untouched through 2007— it could have grown to $1,176. But missing only the top 20 months in that 120-month span could have cut your accumulated wealth to $498. The market moves swiftly and without warning. The risk of getting out and waiting for more stable times doesn’t work because nobody knows when the big up days will come.

Today’s media structure demands that commentators present new ideas every single day in order to to build ratings. This structure is not conducive to high returns. Those who try to defend Cramer’s reckless call to exit the market say that he merely told people to take out the money they will need over the next five years.

You really think main street viewers of The Today Show calmly got out their calculators and decided to take out that exact amount? No way. The average 401k investor called up his broker in a panic.

Cramer misused his credibility to lead these people into the ultimate bottom trap. He has a right to his own opinion and I think it would have been fine to make this recommendation to a group of private clients, but it was out of line to suggest such a thing to his broad national audience. Consider the ramifications if everyone sold out of the market. Absolute chaos. He should stick to what he does best-research quality companies, recommend stocks and promote diversification. Nobody should serve as a national market timer.

In Cramer’s own words from a recent book he says, “I have been able to make big money when big money could be made because I didn’t get discouraged or fed up or desperate when times got tough. I knew that when the game eventually turned, I would be there to pounce on what was to be gained. Staying in the game makes sense rationally and empirically because, over the long term, we know stocks outperform all asset classes. The reason why more people don’t get rich with stocks, though, is that people can’t seem to stay in long enough to win. They get bored, tired, frustrated, defeated, or reckless. They get discouraged. They get beaten by the unnerving and jarring and humbling process not of investing but investing successfully.”

Buy and hold doesn’t mean that we buy stocks and just bury them away. The buy and hold approach should focus on selecting quality companies with current market values that are at a discount relative to their underlying economic value. By accumulating these issues selectively over time and holding them, an investor minimizes transaction costs while maximizing the possibility of enjoying the long-term returns generated from the business. With the overwhelming correlation between corporate profit growth and long-term share price appreciation, there is quite a bit of wisdom in this approach. Proper asset allocation is an important part of any buy and hold strategy; that is the key to success, not market timing.

Points to remember:

  1. Historically, although past performance is not indicative of future results, a buy-and-hold strategy has resulted in higher gains over the long run.
  2. A big risk of market timing is missing out on the best-performing market cycles.
  3. Missing even a few key months can substantially affect portfolio earnings.
  4. Though buy-and-hold is a smart strategy, regular portfolio checkups are necessary.
  5. Time horizon is particularly important when determining asset choices.
  6. As goals get closer, portfolios should be rebalanced. (Axa equitable)

Only a fool throws out timeless investment principles at the top of the market and only a fool throws them out at the bottom. By deviating from the proven principle of buy and hold, Jim Cramer may look good in the short run but his long term success will be fleeting. Still hanging on my wall today is a picture given to me by my youth basketball coach showing a vintage ‘Hoosiers-like’ hoop with the following phrase written below, ‘You miss 100% of the shots you don’t take’. My word to the wise-don’t get out of the market at these distressed levels. Remain patient. There are plenty of catalysts that will lift this market in the future. History is on your side.

Disclosure: Author is long IVV