August 25, 2009
The CAPM has its faults, and it’s not the only way to estimate risk, so Bolster and Trahan used the Fama-French three-factor model, too. And again, they found an alpha of 0 overall, but looking year by year, they found that Cramer had a negative alpha that was statistically significant in 2006, but positive and statistically significant in 2007. Because the other factors in this model, besides the market factor, represent size and price/book, they found that Cramer was tilting toward small-capitalization and value stocks.
But they suspected that something else was afoot. So they added a momentum factor to the three-factor model, and sure enough, there was strong statistical evidence that Cramer’s buys were, on the whole, stocks that had been going up in the preceding thirty days, and his sells were stocks that had been heading down. (The momentum bias had already been spotted by Cramer’s less rigorous critics.)
Bolster and Trahan made yet another pass at the data. They used William Sharpe’s method of style analysis to uncover Cramer’s investment style. In this approach (a constrained regression analysis), the result is a set of weights on a series of factors, representing management styles, where the weights must sum to 100%. For the factors, they used the Russell indices, and determined that the volatility of Cramer’s results during the measurement period could be fairly closely reproduced by a combination of 18% Russell 1000 Growth, 29% Russell 1000 Value, and 53% Russell 2000 Growth. This seems to conflict with the previous analysis, which showed a reliance on a combination of small-cap and value stocks, but as one member of the audience pointed out, there can be a lot of uncertainty in the weights derived from a Sharpe style analysis, and Bolster and Trahan had not estimated the statistical confidence intervals.
To push their analysis further, Bolster and Trahan repeated the style analysis year by year. This revealed that, while the emphasis on growth was continuous, there was a shift from large-cap value into large-cap growth from 2005 to 2007.
But even this analysis was predicated on the original assumption that Cramer held his buys until he issued a sell recommendation. So Bolster and Trahan repeated their style analysis, but assumed a 60-day holding period for the buys, after which the stocks were sold. Now they found both that Cramer relied even more heavily on growth than they had first estimated, and that there was a more pronounced shift from value to growth from 2006 to 2007. Because growth hugely outperformed value in 2007, Cramer’s shift to growth explains the change from a negative alpha in 2006 to a positive alpha in 2007.
And what about 2008? Bolster and Trahan’s results have not yet been published, but their preliminary report is that Cramer’s portfolio returned -41.5%, versus the S&P 500 return of -38.49%.4 His beta decreased to 1.06, but he had a slightly negative alpha. And his style emphasized a combination of large-cap. growth and small-cap. growth.
The foregoing analysis may resemble the application of a sledgehammer to a walnut, but sledgehammers come in different sizes, and members of the audience on Tuesday evening suggested alternative assumptions for constructing portfolios from Cramer’s advice. We have not heard the last word on Cramer’s stock-picking skills.
So are those professionals who deride Jim Cramer’s stock-picking correct? Professor Bolster stated his overall conclusion: “He has an alpha of 0; he could do worse. He’s harmless.”
4 This was the Bolster and Trahan figure. The official result reported by Standard & Poor’s was -37.00%.
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