Cramer Looks Back: A Trader Changes His Stripes

James J. Cramer recounts the horrors of 1998 in the first of a five-part series.
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(Editor's Note: James J. Cramer, co-founder of, is getting some rest and relaxation with his family this week. But in order to give you your daily Cramer fix, we've got a special five-part series from the trader. In this series he will focus on what went wrong during 1998. He kicks off with an overview of the tough year that was.)

For most of my 12 years in the hedge-fund business I have run my money two ways, half trading and half long-term. The notion of the bifurcated portfolio always made sense to me. At any given time there are stocks that are hot and stocks that aren't. If you can trade the stocks that are hot, and take good profits, those can subsidize your longer-term positions that allow gains to accumulate tax-free.

The split wasn't happenstance. My wife, when she ran my trading desk, recognized that my true calling was in picking undervalued stocks. Her true calling was in reading the tape, assessing supply and demand and analyzing accumulation and distribution. She was a technician; I was a fundamentalist. We split the portfolio up to take advantage of those two strengths.

When my wife retired after we had our second child, I was always concerned that I would not be able to trade as well as she did. I knew I could find undervalued stocks as part of my daily work. But trading took a skill that needs practice, a level of patience and an inner fortitude that I feared I lacked.

That's why last year came as such a shock to me. It was my trading that blossomed, but my small-cap portfolio that killed me. That's why I decided come the fourth quarter that I had to change my style or risk becoming like the dinosaurs of previous eras who had not kept pace with the amazing changes in both the market and the economy.

As a manager, though, you don't change styles lightly. First, you can't just throw out a style that has served you well for so many years. How do you know that it won't come back in vogue? Second, your investment partners are all used to your one way of doing things. What will they think of the changes?

But in the end I knew that if I stuck with the value portion of my portfolio, I would be crushed. The small-caps had to go. The orientation toward out-of-favor little guys had to end.

The summer of 1998 brought that home to me more than any time in my career. I had my first truly horrible quarter, one that would cause many partners to lose faith in me and lead to massive redemptions. My change in style, coming on top of that, did not sit well with most.

But I think it may have been the smartest thing I have done for my partners in some time. The amazing thing about this business is that you can


be so inflexible as to ignore what the market is telling you. Sure, there will be short-term shifts and changes that you can skip or avoid. But the world has changed. Large pools of capital that did not exist 10 years ago, giant mutual funds, now rule. They can't own small-cap stocks because they can't buy enough of them to make a difference to their performance. Much money is now run as part of the

S&P 500

, which has become a benchmark that few active managers have beaten over a long period of time. (I feel fortunate to have done so for the last 10 years, but it hasn't been easy.)

Nevertheless, the switch in styles led to a true gaffing, as I had to kick out my small-caps into a market that cared not one whit for these stocks. More important, the whole orientation kept me from doing what I do best, which is finding the companies that I think the market will like -- ironic, given my love of the Net and my embracing it so vividly.

What follows are two stories, one a true small-cap horror show, and the other, a fond adieu to a style of investing that made me a fortune, but now, to put it bluntly, stinks. I will not go back.

I would have loved to keep the style change to myself. I didn't want people to know I was liquidating small-cap stocks, information that can lead to tremendous pressure against the stocks as others seek to benefit from your misery. But one of my ex-partners craftily sent my mea culpa performance letter for the end of the year to

The New York Times

-- you think they would ever send the 12 years' worth of good ones? So now I want to set the record straight about some of the things that went wrong last year.

The biggest disaster, despite issues related to small-caps, remains my Oct. 8

fiasco, when I felt the ceiling caving in even as the market was putting in a bottom. I shared my heartbreak with many of you during that episode. That nightmare, in retrospect, was also colored by the massive redemptions that my ex-partners visited upon me at the bottom of the market last fall.

I am willing to go into any aspect of the investing and trading business except the details of my partners. That's private. Even the ex-ones -- for while some of them have no mercy, I know what is right and wrong.

Tuesday: A Fast Modem Ride to Nowhere

James J. Cramer is manager of a hedge fund and co-founder of Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending an email to