Don't Get Squeezed by Cramer's Embrace of a Medieval Mathematician

For financial journalists genuinely interested in the welfare of investors, Jim Cramer is the gift that keeps on giving. His Mad Money show is an inexhaustible supply of misinformation, designed to keep ratings up and increase advertising revenues for the financial services industry, with little concern for the harm he causes investors.

In a recent show, Cramer addressed an issue troubling many investors: With the recent run-up in the markets, should investors take their profits and sit on the sidelines, or will the market rally continue? One responsible answer to this question would be to remind investors to rebalance their portfolios periodically, to ensure their risk level remains suitable. Another would be that no one has the expertise to reliably and consistently predict the direction of markets with any accuracy greater than you would expect based on random chance. Cramer gave neither.

"This is the kind of issue where it really pays to check your emotions at the door and think about things empirically," Cramer noted.

So far, so good. Here's where his advice goes off the tracks.

CNBC producer Lee Brodie wrote, "Whenever pros such as Jim Cramer need to take emotion completely out of the equation they turn to technical analysis to see what chart patterns suggest."

Really, that's what "investment pros" do? They rely on technical analysis to predict the future direction of the markets? You have to wonder exactly how that process works. No need to wait. Cramer enlightened his viewers with a guest who is an expert at charting "Fibonacci levels." These charts rely on the analysis of -- stop me if you guessed this -- a "medieval Italian mathematician, Leonardo Fibonacci." You can't make this stuff up.

Maybe that's why "investment pros," such as fund managers of actively managed funds and hedge fund managers, have such a poor track record when you compare their risk-adjusted returns over the long term. Most of them underperform a comparable benchmark index. In fairness, I can find no support for the view that "investment pros" base their investment strategy on Fibonacci's work. I was not surprised that Brodie failed to mention the names of any that do, other than Cramer. Cramer's lack of stock-picking acumen has been well-documented. In this blog post, I summarized the studies supporting the view that his track record is no better -- and arguably worse -- than the results you would expect from a monkey throwing a dart at a board of stocks.

Before you base your retirement planning on the work of someone who died in 1250, you should take the time to review the studies setting forth the poor track record of technical analysis. These studies are exhaustively set forth in Burton Malkiel's seminal book, A Random Walk Down Wall Street and in other academic studies.

The underlying flaw with using technical analysis to predict the direction of the markets is twofold:

1. Past prices have little predictive value.
2. If there was a formula for predicting future prices, it would lose its value once it was disseminated to the public, because investors would be quick to act on it.

By endorsing the use of technical charts as predictive tools, Cramer is selling out his viewers to benefit his advertisers. This tactic is familiar to clients of many brokers, who have seen their retirement savings decimated by poor, often conflicted advice, that benefited brokers at their expense.

The idea that there are "gurus" such as Cramer and other self-styled pundits who can predict the direction of the markets, or future prices of stocks, is a primary reason why so many investors fail to capture market returns that are theirs for the taking. It is the basis for a talk I give to investors called Seeking Alpha and Getting Clobbered.

Fibonacci was a brilliant mathematician, but even he couldn't predict tomorrow's news. Don't bet your financial future on anyone who says they can.

Dan Solin is the director of investor advocacy for The BAM ALLIANCE and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.