Swedroe: Don’t Go ‘Mad Money’

August 10, 2018

Cramer’s sell recommendations also affect prices, though the impact doesn’t quickly reverse:

  • The abnormal returns were negative (-0.73%) and statistically significant on the day his sell recommendations hit the market. They were also negative (-3.24%) and statistically significant in the 30 days prior. Again, this suggests Cramer picked stocks based on momentum.
  • Unlike with his buy recommendations, returns remain negative and statistically significant for days one through five (-1.22%) and days one through 30 (-3.11%) following the sell recommendation.

Over the full period, a portfolio of Cramer’s picks lost 7.32%, slightly better than the S&P 500 Index’s loss of 8.72%. However, once returns were adjusted for exposure to the four factors, the results were all indifferent from zero. In addition, 98% of the returns to the portfolio of Cramer’s stock picks were explained by those factors. In other words, there is no evidence of any stock-picking skill—his picks are neither good nor bad. In the end, it’s just entertainment.

More Madness

The results of this study basically replicate the findings of a May 2005 study, “Is the Market Mad? Evidence from Mad Money” by Joseph Engelberg, Caroline Sasseville and Jared Williams, then three Ph.D. students at Northwestern’s Kellogg School of Management, including the fact that Cramer’s recommendations were momentum stocks.

They found that volume soars when Cramer recommends a stock. For example, the researchers found that, on the smallest quartile of stocks, volume is almost nine times more than normal on the day after his recommendation (and stays above normal for about four days, with the effect decreasing over time). Increased demand led to an overnight rise in prices of about 5% for the smallest stocks (where it can have the greatest impact), and about 2% for the authors’ entire sample of 246 unconditional recommendations made between July 28, 2005 and Oct. 14, 2005.

Unfortunately, the profits turn out to be as illusory as the tooth fairy—the run-up in price completely reverses within 12 trading days. The original gains turn into nothing more than market impact costs. In other words, after costs, Cramer’s picks have negative value to investors who act on his buy recommendations. However, the market is so efficient that there may be people who benefit from Cramer’s picks.

While demand for Cramer’s stock picks increases, short-selling volume (bets that the stock will fall) also increases. In the opening minutes of the day following a recommendation, short sales increase to almost seven times their normal levels, and they remain elevated for three days.

Who are these short-sellers? Likely candidates are hedge funds, who are exploiting the naivete of individual investors. Through their actions, short-sellers are helping keep the market efficient.

Consider A Shorting Strategy

There is one other study, “Shorting Cramer,” to review. In a 2007 column, Barron’s reported that it studied 1,300 recommendations and found, over the prior two years, viewers holding Cramer’s stock picks would have been up 12%, while the Dow Jones industrial average rose 22% and the S&P 500 Index rose 16%.

The research makes it clear that being highly intelligent (and entertaining, in Cramer’s case) is not a sufficient condition to outperform the market. The reason is simple: There are many other highly intelligent money managers whose price discovery actions work to keep the market highly efficient (meaning market prices are the best estimate we have of the right price). That makes it unlikely any active money manager will outperform on a risk-adjusted basis.

Cramer himself provides a fitting conclusion: In a 2007 issue of New York magazine, he stated: “God knows why, but there seems to be a market for this kind of idiocy.”

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