Good Buy, Mr. Dips : Manager Has a System for Striking When Market’s Down
Jim Cramer is one of the reasons the stock market has eluded getting crunched by the Big One over the last seven years.
A major-league hedge fund manager when he’s not busy fussing over his new financial news Web site, Cramer is one of those smart-money guys who has stepped in to purchase stocks heavily every time broad market averages have sunk sharply for a few days straight. Undaunted by finger-wagging warnings from bears and economic historians that one day a whopping correction will prove him deadly wrong, he credits the technique for his 28% return last year. And wonders why anyone wouldn’t do just the same.
“I am Mr. Buy on Dips. I am definitely that--I make no bones,” Cramer said from his office in New York. “It has been the single best strategy for the past seven years, and I am not changing my stripes.”
The defiantly contrarian strategy at Cramer, Berkowitz & Co. sounds easy. But throwing money at the market when seemingly all others are selling requires conviction, courage and, most of all, cash.
It also requires a timing tool that helps you figure out when the nation’s trillion dollars in mutual and institutional funds are going to trail right behind your decision.
Books on technical analysis are full of esoteric measures with names like stochastics, Bollinger bands and Japanese candlesticks. But Cramer--a former Los Angeles Herald-Examiner reporter, Harvard-trained attorney and Goldman Sachs banker--says he has figured out a way to keep it simple.
After attempting to nail down hundreds of correlations between major market reversals and changes in statistics such as long bond yields or inflation rates, he contends he’s found the best gauge of market value to be the Mutual Fund Index listed in Investor’s Business Daily.
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Here’s the concept:
The index, depicted in the newspaper as a nine-month chart, consists of 23 of the nation’s top-performing growth-stock mutual funds, such as Brandywine, AIM Aggressive Growth, T. Rowe Price New Horizons and PBHG Growth. That makes the index a barometer of the conventional wisdom on the value of top growth stocks like Intel, Microsoft, Cisco Systems and General Electric.
For the last seven years, Cramer says, every time the index has dipped to its 200-day moving average or below, “it’s been a fabulous time to commit new capital” to those leading growth stocks. Conversely, whenever the index moves well above its 200-day moving average, he says, it’s been a great time to lighten up.
Unlike most market timers, who can yammer on about complex mathematical formulas that describe precise entry and exit points for their systems, Cramer coarsely measures the movement of the index by the grid boxes in the IBD chart. A move of three boxes above the 200-day moving average is a sign of over-exuberance on the part of fund managers, he asserts, while a plunge to two boxes below the moving average is a certain signal to max out on margin and buy Intel like mad.
Naturally, I was skeptical. Scholarly research suggests that market timing systems’ results are dismal, and this technique sounded unusually weird.
But, hey, whatever works. Cramer, who gave up a column at Smart Money magazine after a brief dust-up with the Securities & Exchange Commission over ultimately unproved allegations that he was front-running stocks, was telling me about the system on Jan. 22, when the line had moved 2 1/2 grid boxes above the 200-day moving average.
“When I saw that this morning, I said: ‘Oh, God! It’s too high. Time to lighten up,’ ” Cramer said. “I sold into the strength. It means that the funds have gotten too excited and put too much money to work.”
He said he was dumping 30% of his growth stock positions, including a lot of IBM. And sure enough, that day turned out to be the recent high. IBM lost 15% of its value over the ensuing four days, sinking to $144 from $169.
“It takes a tremendous amount of guts to step to the plate and take a swing, either when you’re selling or buying for clients,” said Cramer, whose opinions are published twice a week at TheStreet.Com, an insightful financial news Web site he co-owns (https://www.thestreet.com). “But I’m in the business of outperforming the market. That means I have to be a little earlier on the big moves and I have to avoid the downside. You can’t beat the market if you’re going to say it’s all overvalued and you’re going to stay away. That’s been the absolute worst solution. . . . So all other fundamental factors being equal, I feel absolutely certain that there isn’t anything else out there that’s better than this index as a method of quantifying when to buy on dips.”
Lawrence E. Harris, a professor of finance at USC’s Marshall School of Business, believes that Cramer’s system of buying on dips is working because both public and private investors have learned to be more tolerant of market risks over the last 10 years.
They have truly heeded the advice from scholars and professionals that stocks are a better long-term investment than bonds or cash, he said, and become willing to buy more of them when they appear to be on sale in a modest decline.
“There’s a difference between uncertainty and risk,” he said. “Stock prices today are just as uncertain and volatile as they’ve always been. What’s changed is that people aren’t as afraid of the uncertainty as they used to be.”
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On the other hand, Harris fears that the public’s new risk tolerance is made up of equal parts naivete and bravery. Unsophisticated investors, he said, often make the mistake of thinking that if it was possible for a stock to hit a recent high once, it’s probable that it will return to that price. But that ain’t necessarily so.
“People who mistake possibility for probability will tend to overvalue stocks,” he warned.
Harris, therefore, scoffs at Cramer’s system, observing that the human brain is little more than a signal-recognition device.
“During your entire life, your mind is trying to interpret the world,” Harris said. “When it sees things for which there is no pattern, it will still see a pattern anyway.”
He added: “People make money in the market according to the quality of their information. If you have a strategy that is based on information available to everybody, you have no reason to believe it’ll beat the market.”
Indeed, Herbert Kaufman, chairman of the finance department at Arizona State University, said major studies have proved that even an investor who picked the very worst time to buy stocks each year would have done well over the last quarter of a century.
In a benign economic environment with low inflation, modest interest rates and good corporate earnings, he said, choosing the time to invest is not nearly as important as simply choosing to invest.
Street Strategies explores investment tactics. Jon D. Markman is a Times staff writer. He may use strategies described in the column. He can be reached at jon.markman@latimes.com
