The turmoil doesn't extend just to the Dow Jones Averages. Under the heading of keeping perspective in my life, I am taking leave of TheStreet.com for a couple of days to attend to some urgent business at home. My father is going in for an operation today in Philadelphia and I will be at his side, and then tomorrow my wife will be operated on to fix her wrist. It was set badly last fall and has to be re-broken, and bone grafted. Obviously, I will be at her side, too. So my filings will be extremely limited. I figured, if I gave you a heads-up, you would understand.
Common sense vs. book sense. Street smarts vs. formulaic wisdom. Experience vs. depth of knowledge. These tugs-of-war are age-old and cross all sorts of professional lines.
I know my everyday logic embodies a mixture of both, but I am heavily dependent on the former of each when it comes to the stock market.
It wasn't always like this. There is a classical training of security analysis that I once called my own. I wasn't always preaching from the church of what is happening now.
Sixteen years ago, I went to
after law school, where I learned everything I could about the fundamentals. I think you could say I was as steeped in the principle of buy and hold as anyone else. I know you could say that few in sales cared as much as I did about the traditional benchmarks of value.
I spent some time in the research department, learning how the great analysts thought. I read any literature possible about traditional security analysis. And while I had been an active daytrader before I went to law school, and became obsessive about trading in law school, I recognized that most of what I did was based on instinct and some research before I got that training. I knew I needed some sort of grounding to believe in. Goldman Sachs systematized the process for me.
First, why is such a system necessary? At Goldman Sachs in 1983, the research department followed 600 stocks. It needed some sort of principal based on earnings and valuations to order that universe. It melded macro and micro concerns to get that list right. You can't just go into a research meeting and say, "Get a load of this INSP chart."
You can't talk breakouts and breakdowns. And you can't just tell a story with no financial grounding even if you think in your heart of hearts that it is going to go higher.
I remember, as a trainee, when I first started, I had to pick a stock to sell to the research director. Even though it was a mock presentation, I was scared to death. I wanted to do something that I knew really well, and as my dad had sold kraft paper at the time for
, I knew that company well and I chose to recommend. (Coincidentally, I am long that stock now.)
The research director listened dutifully to my two-minute pitch about how well the business was doing. He then dismissed it and me with, "Wrong time in the cycle for this stock, forget it."
I was deeply hurt, I had no idea what the heck that meant. If International Paper was good, it was good, I figured. Six months later, I was mortified that I had picked International Paper. At that point in the economic cycle, only a moron would have recommended International Paper.
I became a true believer in the notion that there was a time to own cyclicals and a time to own soft goods. And there was a time to own home-builders and a time to sell them. That had to do with how the
was viewing the economy.
If the Fed was reflating, you could buy cyclicals like International Paper. If it were tightening, you couldn't be more wrong. You had to buy International Paper when its premium to the market was huge, and sell it when its multiple had shrunk.
I was recommending International Paper after the multiple had already shrunk. I was recommending it at the top! Layered on top of the macro view that started it all for me, was the notion of the normalized earnings power of a stock.
The reasoning went like this: If you could buy a stock at a discount that historically sold at a premium to the market on an earnings-per-share basis, you had a good chance of being right on the money. Same thing if you could buy something at a discount that normally sold at a premium. The whole notion of a research department is to create merchandise that statistically has a good-enough chance to go up so that people might be interested in buying the goods.
As a salesperson, I wanted to have traditional grounding of the ideas so I could have less of a chance of getting burned. The analysts themselves were certified, meaning they had traditional training in the rules and metrics that have historically generated winners. The methodology of the place was irrefutable. The rigor of it, the empirical data buttressing it made all of the sense in the world. The ordering principles produced great stocks.
For the 1980s, this method worked pretty consistently. Remember, we have been in a bull market for so long that we take it for granted that some methodology is working. (Bears: No I don't think we should be complacent, but man, has complacence made a lot of money.)
But when I left Goldman Sachs in 1987, I met Karen Backfisch, who was then a trader on Michael Steinhardt's desk. Steinhardt ran a hedge fund before there was a ton of hedge funds. I sat next to her and watched her. I learned from her. I eventually went into a 50/50 partnership with her and later we got married.
My wife, who was trading hundreds of millions of dollars in stock for her own profit-and-loss statement at Steinhardt, had no classical training whatsoever. Karen was a research assistant/secretary whose boss got fired after one month. She was living at home in Elmont, Long Island, and had no desire to go back to making fries at the Mickey D's she had once worked at down the block from her house on the Hempstead Turnpike.
My wife is about common sense. She is about street smarts. She is about figuring it out before somebody else figures it out. She begged for her job, and Steinhardt let her sit on the trading desk. She made money, she stayed. She lost money, she would be fired.
Karen Backfisch was not going to start learning about the discounted free cash-flow methods of evaluating cable companies when she was on that desk. She wasn't going to do relative price-to-earnings analysis. She took notes from brokers and watched scrupulously to see what worked and what didn't work. She tried to replicate what worked and avoid what lost money. She reviewed what worked and what didn't work. Over and over and over again.
And she was a very big success.
When I met her, she had been making money for about four years. It was difficult at first to figure out what exactly she did to make money. It seemed awfully hit-or-miss to me. Amazingly, of course, what I did seemed totally hit-or-miss to her. I mean, she would say, who cares about the relative price-to-earnings of the drug companies? What mattered was whether you thought something was a good, promotable idea that brokers would get behind. What mattered was whether the public would take a shine to an idea. What mattered was whether Jack Grubman was behind it. Or whether Goldman Sachs was behind it. Or whether someone with a hot hand wanted it to work.
She explained to me the power of promotion and the rec list. She worked hard to figure out whether something was a 1-point push or a 2-point push. She had these copious notes she and all the other traders had taken each morning, and she would look to see which calls worked and which didn't. She would see how the last five push of
worked. Or how much a
She was an enyclopedia of what was working right then. Right at that point. When she later left to run my trading desk, I discovered all sorts of fabulous rules and points that she said would work regardless of the tape. (And believe me, she could care less which direction the tape was going.)
She was oblivious to being short or long. She didn't even like to go home with positions.
My wife left the firm six years ago to motherhood, but the lessons she taught me now make a whole lot more sense than the things that Goldman Sachs taught me. Lessons like, "You have to buy them when you can, not when you have to" work much better than any fundamental shibboleth.
Bulls, bears and pigs is a better defense than book value. Knowing what the public might like, knowing what can be promoted, is really all that matters in this tape. Do I wish that my wife's ways had trumped my ways? Not especially.
I loved looking up companies and doing research to try to find undiscovered undervalued stocks. And I loved ranking stocks among sectors, priding myself in knowing that
was better than
was cheaper than
But that isn't what makes you the money these days. What matters is what Karen Backfisch taught me. Which is why, when I take a ribbing for not doing the "rigorous" style of investing that the value folks practice, I have to laugh. Believe me, I would do it in a heartbeat
if it made me money
. I want nothing more than to find the cheapest savings and loans and the best drug stocks on a normalized price-to-earnings basis.
I love playing the steel cycles at the trough or going short overvalued chemical stocks at the peak.
What makes you money in this market, though, is what made Karen money at Steinhardt. Those rules apply. The classical ones don't.
When it switches back, I will, too. Until then, I am strictly applying the logic of the Trading Goddess. And what great and bountiful and wise logic it is.
James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund was long International Paper and Goldman Sachs. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. 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 at