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In defence of Jim Cramer’s call to sell stocks in October 2008

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[embedded content]In retrospect, this seems like terrible advice. Someone who had bought the Wilshire 5000 index of publicly-traded US stocks on October 6, 2008 would today be up about 180 per cent after reinvesting dividends.One man who seems to have listened to Cramer, to his apparent detriment, is Marty Bannon, father of Steve Bannon. From a recent Wall Street Journal profile, with our emphasis:With his children’s security a priority, Marty Bannon began accumulating phone-company stock, which AT&T occasionally made available to employees…he viewed the shares as an inheritance for his children, a lesson in the value of hard work and stability…Then came the 2008 market chaos…Marty Bannon says he lost more than 0,000 because he sold the shares for less than he paid for them.It was a

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In retrospect, this seems like terrible advice. Someone who had bought the Wilshire 5000 index of publicly-traded US stocks on October 6, 2008 would today be up about 180 per cent after reinvesting dividends.

One man who seems to have listened to Cramer, to his apparent detriment, is Marty Bannon, father of Steve Bannon. From a recent Wall Street Journal profile, with our emphasis:

With his children’s security a priority, Marty Bannon began accumulating phone-company stock, which AT&T occasionally made available to employees…he viewed the shares as an inheritance for his children, a lesson in the value of hard work and stability…Then came the 2008 market chaos…Marty Bannon says he lost more than $100,000 because he sold the shares for less than he paid for them.

It was a decision he made without consulting a broker or his family, including his two sons with investment backgrounds, who only learned about the sale days after it was finished. The shares subsequently regained much of their value…That Oct. 6, financial analyst Jim Cramer told “Today” show viewers to pull money from the stock market if they needed any cash for the next five years. Steve Bannon says the warning spooked this father.

The narrative almost nudges the reader into thinking Jim Cramer is partly culpable for America’s nativist turn. But whatever one thinks of Cramer and his calls over the years, in this case, that insinuation would be unfair.

For starters, Cramer’s advice, taken literally, would have been reasonable regardless of what was going on in the outside world. Stocks may generate robust absolute returns over long periods of time but they are also extremely volatile. This makes equities a good investment for a young person to hold in a retirement account and a lousy investment for anyone who expects to need the money any time soon.

If you hold any money in stocks that you expect to spend in the next few years, you should sell it immediately. Anything else is poor risk management. Whether or not stock prices end up rising is irrelevant to that argument.

Suppose, though, Cramer wasn’t making a general point about which assets to own to cover your expected liabilities. Suppose he was simply making a market call that, as of October 6, 2008, you were better off selling your stocks than holding onto them.

As with any market call, Cramer was saying he knew better than the collective judgment of people managing tens of trillions of dollars of assets with the help of some of the smartest workers and most powerful computers. That collective judgment can be wrong, but it generally isn’t wrong in predictable ways. Any call about the market’s direction is therefore inherently suspect.

The question is whether Cramer was simply reinforcing the panic of investors, or actually expressing a justifiable view. Looking back, the evidence suggests Cramer’s recommendation was reasonable at the time. It might even have been better, at that time, than calls to blithely keep buying stocks on the assumption they had just gotten cheaper.

Try to remember what the world was like back in the autumn of 2008. The US economy appeared to be in freefall with worse still to come. Thoughtful people were worried about a re-run of the Great Depression, in large part because they questioned the competence of policymakers.

On October 3, 2008, Ray Dalio and Bob Elliott of Bridgewater Associates published an unusually long note to clients about the risks they saw. There was lots of detail about short-term debt rollover schedules, but their main concern was that the government wasn’t up to the task of solving what should have been solvable problems:

In reflecting on how we got here, we believe that it was not because there were big, damaging surprises as much as it was because of bad piloting. A year of more ago we all knew that financial institutions were highly leveraged with mortgages and other assets that had lost a lot of value. And we all knew that existing accounting rules meant that these institutions would have liquidity and solvency problems. We also knew that these institutions had other exposures (off-balance sheet, derivates, etc.) and their linkages to the real economy (through credit creation) were large and threatening to the system.

So a year ago or so we all knew that we were going to be flying into this storm. Though no one knew what the exact twists and turns of this storm would be, we certainly knew that it would be a big one and we knew roughly how it would transpire. For this reason, we had expected that our pilots would put together contingency plans to keep us safe.

Because there were numerous such storms that were flown through by other pilots in the past, we knew and expected that our pilots would study how they were classically handled and employ the obvious protections…While we don’t know exactly how far ahead they planned and what those plans were (because they weren’t communicated), it appears to us that our pilots were repeatedly taken by surprise by events that they should not have been surprised by.

They went on:

We believe that whether the crisis improves or worsens will be determined more by the quality of our policy makers’ management than by anything thing else, and that we are pessimistic because of the previously explained reasons.

We regret to say that we expect conditions to continue to deteriorate because circumstances are not being well handled, and that these worsening conditions will eventually prompt governments (via their central banks and treasuries) to de-facto nationalize (in varying degrees) all critical financial institutions that are impaired and to provide liquidity (probably through these financial institutions) and/or financial guarantees to key non-financial institutions that are in jeopardy of defaulting on their debts.

Market prices broadly vindicated this argument, at least for a while.

The value of US equities fell by more than a third between October 6, 2008 and the bottom in March, 2009. The option-adjusted spread on high yield bonds rose by about 9 percentage points between early October and mid-December. They didn’t narrow back down to their pre-October levels until May. Home equity levels flatlined for years.

No wonder Alan Greenspan, the supposedly ideological Ayn Rand-loving libertarian, was recommending bank nationalisation and restructuring as a solution to the crisis as late as mid-February, 2009.

That path wasn’t taken (perhaps it should have been), but the combination of aggressive monetary stimulus, fiscal expansion, revised accounting rules, and the government’s declaration it would stand behind all the surviving banks ended up proving potent by mid-2009.

Policymakers could have made different choices, however, or executed them less well, and ended up producing much worse results. In those scenarios, Cramer’s October 6 advice would have been extraordinarily valuable.

To get a sense of the potential downside, start with America’s Great Depression. Stock prices didn’t surpass their 1929 peak until the mid-1950s — and that doesn’t even account for inflation. Of course, the 1929 peak was the top of a bubble and not a fair point of comparison.

Consider instead the value of shares at the start of 1931. This was more than a year into the global downturn and after US share prices had tumbled 49 per cent from the peak. It took until late 1936 for share prices to recover, but that was a brief respite before the “Roosevelt Recession” of 1937. It wasn’t until the end of 1945 that American share prices finally surpassed their 1931 levels for a sustained period, and that was only in nominal terms. In real terms, share prices didn’t surpass the 1931 level until the mid-1950s:

In defence of Jim Cramer’s call to sell stocks in October 2008

Maybe the Great Depression is too extreme for your tastes. So many institutional reforms were made in its aftermath that a repeat would have been unfathomable.

Then consider Japan. It’s done much better in the wake of its investment bust than it typically gets credit for, but investors in shares were still obliterated. Even now, Japanese equities are worth about a sixth less than they were at the start of 1988. (Starting the clock in 1989 or 1990 produces far bigger losses, but we wanted to be generous.)

Or look at Sweden. It too had a massive bubble, followed by a financial crisis, in the late 1980s and early 1990s. Unlike Japan, it aggressively restructured its banks and instituted a host of reforms. Sweden’s handling of its crisis is often considered the model for others. Yet none of this helped investors in Swedish stocks, which were flat for years and sharply down after accounting for Sweden’s rapid inflation.

All of those examples are in the past. Policymakers have learned from them, supposedly. So instead look at what’s actually happened in Europe more recently.

Greek stock prices have plunged more than 90 per cent since the mid-2000s. That’s probably even more extreme than what Cramer and Dalio were thinking of in October, 2008, but it gives a sense of the downside risks and the potential wisdom of selling shares even after prices have fallen. After all, a 90 per cent loss is a 50 per cent loss followed by an 80 per cent loss.

Even looking beyond Greece, it’s clear the legacy of the crisis has been devastating on European share prices. It’s taken a decade for Dutch and French stocks to barely breach their pre-crisis levels, while Italian and Spanish stocks are still trading about 51 per cent and 32 per cent below where they were in 2006, respectively.

It would have been foolish and arrogant to have assumed, in October 2008, that American policymakers were destined to do far better than their European counterparts. Even if officials on both sides of the Atlantic had split the difference, the implication is that US stocks would have been incredibly risky during Cramer’s forecast period.

Put it all together, and Cramer’s advice on October 6, 2008 was sound, especially given what was known at the time. Things happened to have turned out well for American stock investors, but there is little reason to think that was the likeliest outcome.

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Matthew C Klein
I write about the economy and financial markets for Bloomberg View. Before that I wrote for The Economist. I have worked at the world’s largest hedge fund and read every FOMC transcript since May, 1987