Mad Money, Dull Returns

"We're baaaaack!" So they are, the managers, marketers, traders and other animals in the financial services sector. Had there been a crisis? Had investors suffered painful losses? Had brokers been charging insanely high fees and helping themselves to unmerited salaries, yet failed to warn their clients of the onrushing tsunami? Had there been unrestrained madness, a bubble, a mindless orgy of lending and borrowing, a revelry held at the expense of somebody else?

Yes. "But that was then," shrug the brokers and investment managers. "Nobody could have foreseen it."

Yet they aren't even trying to persuade us that anything has changed, that they learned anything at all, let alone lessons, or humility. Why should they bother to convince us of anything, when they have a much stronger reason to attract our attention: "The market is flying," they say. "Look. It's up more than 50% from the bottom. Look what you missed! Don't you want to get in? Do you want to sit there counting your cash and getting nothing for it, again?"

You see, nothing has changed. On TheMarker Web site in Hebrew there were no less than 30 analyst recommendations for stocks in May alone. That's more than one a day. Most were Buy or Outperform ratings. About a quarter were Sector Perform or Neutral, and there was not even one lonely Sell rating.

The market is hot again. The investment firms' marketing mechanisms are working full steam, mainly the divisions hawking stocks. Today it's stocks, tomorrow it'll be bonds and the day after, you can bet somebody will be pushing you to buy new structured instruments.

Do the analysts know something you don't? Can they really fish out the important things in the tossing sea of information on securities? Are analysts providing added value?

In other words, are they actually helping anybody beat the market? Three new studies seek an answer.

The first study is about the man, the analyst and the phenomenon named Jim Cramer, host of the CNBC show "Mad Money." He dishes up his buy and sell recommendations colorfully, but don't mistake his bombast for buffoonery. "Mad Money" is the most popular television show on CNBC and therefore, the most popular in the investment world.

To answer the question of its usefulness, re the quality of Cramer's advice, two finance professors from Northeastern University collated all the recommendations he'd made on the show from July 2005 through December 2007. Then they analyzed performance based on tests and simulations.

Cramer's returns during that period were 31.8%, compared with the benchmark S&P-500 index's 19%. However, a deeper statistical examination and comparison with his preferred investment type (overweighting smallcaps with low multiples) didn't produce particularly good results, but not bad ones either. The researchers found that Cramer might be affecting the stocks he mentioned on television, mainly when urging investors to sell. Also, Cramer had an advantage over his peers because he wasn't locked into a given investment strategy or avenue.

Can Cramer repeat his performance in 2009? The professors won't say, but they are willing to admit that his TV shows are fascinating, and that as an analyst, he isn't worse than others. Last week, by the way, Cramer advised investors to buy real estate and shares in Bank of America.

A second study looked at analysts' influence from another angle. Two researchers, also from American universities, checked how the market reacts 20 minutes before and after the publication of a buy or sell recommendation.

The average result was found to be 0.03%, in other words, nothing.

That outcome differed from all previous studies, which had found some slight influence on equity prices. The professors point out that the information analysts provide has, in 80% of cases, already reached the public. In other words, analysts bring no real value to investors, and investors know it.

The third study was conducted by Citigroup, which itself publishes equity analyses. It looked at 15 years of recommendations and found that while the markets may move fast, analysts don't. Analysts didn't predict the technology bubble of 2000. Nor did they foresee (to generalize) the current global economic meltdown. Nor were their stock picks the stars of the show.

None of this augurs well for equity analysts' reputation. But the truth is, the reports are little surprise.

Capital market pros don't think analysts are morons. They do believe that good analysts can generate added value, but the information first goes to the analysts' clients and cronies, who hasten to take advantage of it. Only later does the information reach the public, when it has no value left at all.