why he is a true believer in mutual funds

Jim Cramer manages a hedge fund and is a columnist for New York Magazine and the author of Smart Money.

Talk about today’s small investors in the market.

There are two tiers of small investors. There are the people who religiously invest because they’ve been taught by Fidelity, by Peter Lynch, by the magazines, by historical data that the stock market is the best place to invest. And these are people who, in any other field, we would say, Well, they’re just following the empirical data.

And then there’s a whole other tier of people and they’re the tier of people who have no rationality, they just chase what’s ever hot. And these people have now decided that stock are out of fashion and they’re not they tend to be in whoever was a hottest, thereby, make whatever was the hottest the coldest. And that’s what we’re up against.

So all these people who have shoved money into mutual funds are pulling it out?

All the people who shove discretionary income into mutual funds in order to be able to make money, as opposed to invest for retirement or invest in a kind of a historical fashion, in other words, well, for me, I’ve got a two year-old and a five year-old and at the beginning of each year I don’t say, I don’t care. You know, I don’t say, Geez, the market’s really bad this year. I’m not going to invest. I invest for them, but if you have discretionary money and you invested for them, now you’re more than likely on the margin point now.

Now, take the emerging foreign country melt-down that we have in Mexico, Argentina, and Brazil in ’94. Those were the people who sold were people who had chased previously good performance in ’93. Now we have seen those funds suffer massive redemptions, at times being down as much as 40-50 percent. That, unfortunately, is the paradigm for the emerging growth investors this time, because the guy who was chasing ’93’s great performance got crushed in ’94 is the same guy who was chasing ’95’s great performance and is now being crushed in ’96. So he withdrew.

So the guy who jumped into Garret Van Wagoner’s fund this past April and May is the guy who’s pulling out now?

Exactly.

Because he was chasing that 60 percent?

But don’t you have to be a professional to be that shrewd?

I think that there are changes that have occurred in technology that make is that more people can have the same level of information that I have. My advantage is that I’m very good at interpreting the information. The danger that we have right now are people who get the same information as I do and, therefore, think they’ll reach the same conclusions that haven’t traded as long, don’t have bear claws up and down their backs like I do. I mean I’ve lost tremendous amounts of money in various markets and I think that that’s something that makes you better at my job, not worse. I think a lot of the people who are in now haven’t lost tremendous amounts of money yet, don’t want to, but will. But they won’t lose ‘em if they’re in companies that are real.

Such as?

I think that let’s take the case of Phillip Morris. Let’s use Phillip Morris because it’s big and controversial. It’s got a lot of problems from cigarette litigation. I own Phillip Morris. I’m not as big in it now as I was before, because it happened to visit the 80s, it’s now at a hundred. It was down 15-20 points and I bought a lot of it. But Phillip Morris is the highest yielding stock in the Dow Jones. Its yield is safe. The dividend is safe. Its earnings are growing terrifically and it’s going to get pulled down with the rest of the market in the same way that in 1990, Merck and Bristol-Myers initially got pulled down with the rest of the market when Iraq invaded Kuwait. Six months later Merck, Pfizer, Bristol-Myers were up dramatically. A lot of other things kept going down. Six months from now I believe that the same tiering will occur. They will be very solid financial stocks, like a Phillip Morris, that could be much higher. But those stocks have not caught the fancy of the speculative public. The speculative public is indulged in stocks that I have no confidence in. There’s a stock that I am sure of right now, Iomega, that is the third-tier player in a very cyclical market, storage for personal computers. My first-tier players, Sea Gate and Quantum, go down every single day and they’re doing fine. The second-tier players are teetering on bankruptcy. Amax Corp. bought by the Koreans last year, this time Connor Peripherals had to be bought by Sea Gate because it was doing so badly. The third-tier players, Iomega, IMP, historically in this era when PC sales are threatened if there’s a lot of competition in storage, the third-tier players usually cease to exist in six to eight months. Now the idea that Iomega could be wiped out never entered in the minds of any of the people who are involved in Iomega. Iomega became this year’s Bristol-Myers. The problem was that Bristol-Myers was an unbelievably well-managed company with huge earnings, huge assets, great balance sheet, great dividend, and Iomega is a company that just got in the business basically. The balance sheet is fine. The management’s never been tested. Alan Shubart, who runs Sea Gate and anybody would tell you he’s the best storage manager in the industry, is saying we’re in horrendous times. He’s seen every up and down. The people who run Iomega haven’t seen anything. Hewlett-Packard, which is the foremost computer manufacturing company in the business is getting out of the storage business. They find it to be too competitive. How can Iomega make it? Now I’m picky on Iomega in part because Iomega became an entity that people viewed as a savings bond with an earnings kicker. And it turned out to be no more than just a piece of paper that is split many times. I think that that’s indicative of where we’re going.

Tell me why you think the stock market is sort of the ultimate salvation for the middle class in today’s world?

Well, when I speak of the term the stock market, I’m invariably speaking of good American companies that tended to be not that sharp in the ’70s, got sharp in the ’80s, and are now unbelievably good in the ’90s. There are companies out there in our country who historically have not been able to beat the Germans and the Japanese, who now beat them routinely. These are guys who’ve been able to handle any of the slow-downs that we’re seeing in the current economy, or whether any of the interest rate up and down, Federal Reserve cuts, Federal Reserve hikes — these things are just not that meaningful longer term to these great American companies. And these great American companies, by virtue of the fact that they are part of the stock market, can go down as a function of the stock market. Compaq, MicroSoft, Intel, they’re stocks. So, therefore, when the stock market goes down, there’s a good chance that they will go down. And I want to buy them, because historically these have been great engines of enrichment for the middle class, historically meaning now for a good ten years. And I think that’ll continue in the same way that in a previous generation when were under-retailed, if you had bought Wal-Mart Unlimited, you could have become rich. If you bought Intel, you could have become rich away from your job. I don’t think that’s changed at all. I think there are a thousand stocks out there that could make you rich, totally independent of what you do for a living. There’ve been fortunes made in Merck. There have been fortunes made in Pfizer. There will be fortunes again made in Merck and Pfizer.

Then there’s another whole class of stocks that were created to be able to meet this demand that’s come from the tremendous in-flows of capital. Thousands of companies have been created in the last two or three years. They’ve not been tested in an economic downturn. Their managements are not as shrewd and Hewlett-Packard. They’re not as good as a management of Intel. They haven’t seen downturns like the management of Merck. They’re untested and they’re dangerous and what I’m saying is that if you were to re deploy in this morass of a summer market that we have, in situations that where managements are fabulous, where balance sheets are good, where historically they’ve been very shareholder sensitive, nothing’s changed. These will be fabulous investments and will make millions of more people rich.

I’m a huge believer in mutual funds. I think that mutual funds are the antidote to the kind of speculative craziness. The managers tend to be really good and if they’re not good, they’re fired. There’s accountability in the mutual fund industry. And they’ve been tremendous engines of wealth for people and they’re going to continue to be so. Individual stocks would be also great engines of wealth, but for a lot of people it’s just too hard to pick. In the meantime I question who in this country has made the kind of money at their job that they’ve made in their mutual fund? There are periods where mutual funds won’t make any money, but historically no one got a 33 percent raise last year, that I know of, unless they were in an S&P fund. I invest in funds myself even though I run my own fund for my daughters. I have a five year-old and a two year-old and every chance I get that the government allows, I put money in for them in mutual funds. And I don’t really look at the price of the mutual funds because I know that 30 years from now they’re going to be higher. But I would also say that, capitalism is raging rampant across the world. We’re the primary place of capitalism. I believe that stocks like Bristol-Myers, had they existed in the 1800’s there would have no Marx, there would have been no communism because what’s happened is these stocks have made many millions of people rich. And they’re gonna do it again.

Let’s take the quintessential American stocks. Let’s take Merck and Bristol-Myers. If these companies had existed a hundred years ago and everybody was allowed to be invested in them, then you would have had a sizable class of people worldwide who would have been wealthier. I think that stocks have been this tremendous, tremendous equalizer for people in this country. Guys who can’t make a lot of money at their jobs have been able to make a lot of money in the stock market. There are going to be periods when that’s not true, but historically it has been true. If you had bought Merck in the 1950s, just bought 10,000 shares of Merck instead of buying US Savings Bonds, you would not ever have to work again for the last ten years! I mean it’s that simple. The compound nature of the dividends and capital appreciation of Merck for the last 25 years has just been far better than what Warren Buffet has done. It’s been as good as what Bill Gates has done! You know, let’s say you had bought Microsoft when it came public, let’s say you didn’t sell it or didn’t flip it like I did when I got my Microsoft, but you just held onto it. Well, you would be a multi-millionaire. That process is not changing. It’s dynamic. There is another Microsoft out there right now. I am doing my best to find it. There’s another Amgen out there right now. I am doing my best to find it. I will find it before the public finds it. I will get out of it before it’s too late. The reason I will do that is because that’s what I’m paid to do.

Why should middle class people have confidence they can do it, too?

Well, I mean, look, middle class people, they have two options. They can get all the information I do and spend an inordinate amount of their time in their day trying to pick stocks. And I think that’s, for a person of leisure, that’s perfectly good. I think you’ll do as well as most professionals. Most professionals don’t beat the market. Let’s not over-rate my industry. But if you have time, you can be in good mutual funds that have good records. There are people who’ve historically beaten the market both in good and bad times. I’ve historically beat the market in good and bad times. And I will tell you that I will — if you can’t find the next Amgen, I’ll find the next Amgen. If you can’t find the next McDonald’s, I’ll find the next McDonald’s. But it’s vital to be with people who with looking for ‘em, because they do exist. They are created. Microsoft was not a mysterious, strange entity. You put your PC on and there’s an ad for them. You put your TV on and maybe you get an ad from Proctor & Gamble, maybe you get an ad from McDonald’s, maybe you get an ad from Ford, but you put your PC on and there’s just this huge ad for Microsoft. This was not a hard concept to come up with. Now if you couldn’t come up with it, the mutual funds came up with it. Intel. I mean, you know, every personal computer has Intel inside. Well, you know, that doesn’t seem that hard for me to be able to find. Now there are times when everybody recognizes that Intel is great and then maybe Intel get over-done and it comes back down. But, you know, these are companies that in my lifetime have put on 30 and 40 billion dollars of market capital. You know, they couldn’t have been a secret.

Do you think that over the long term stocks will outperform every other investment known to man?

The party line is that stocks historically have outperformed all other investment plans. I can either decide that this time it’s different and that stocks will not outperform, or I can recognize that even in that period of history — there have been periods where it’s been horrendous to buy — or I can just say, Okay. I can’t time it at all and I’m just going to buy with my eyes closed. And, strangely, this one of the few things in life that the third, the latter, the buy with our eyes closed has actually done better than everybody else. Let me give you a stark example of something that I came up with. If you had bought the ten most active stocks on the New York Stock Exchange Friday before the market crashed in October of ’87, and I was trading very actively in October and I mean I, you know, lived through that market — if you had bought the ten most active stocks the day before, arguably the dumbest day in history to ever buy stocks, you would have been up huge three years later. That, to me, is very telling. What that says is, had you just bought in the ten most active, that’s basically saying the ten most popular stocks, if you, name me another class of investment that if had bought the ten most popular ideas of in any particular era that you would be up five-ten-15 years after that moment when the — when the place has crashed — it certainly wouldn’t have worked with gold. These are not tulips. If you were the last guy to buy tulips in Holland before they crashed, you haven’t made a dime! But if you had bought that most active list, you would have made a fortune! It — doesn’t that say that here’s an asset class that works over the long term if you can buy it on the dumbest day in history and make a bundle?

The whole idea that there are actually more people in the market than the numbers would suggest.

I think the numbers about how much stock people own in this country I think are dramatically understated, and here’s why. We typically hear numbers that there are 34 million households that are in stocks in some form. Well, I say that what’s occurred is if you have a job in this country, you’re in stocks. When I see the employment as strong as it is in this country and the job creation, the 10 million jobs that have been created during these last four years, what it says to me is 10 million new stockholders because if you have a job, it’s likely that you have a pension. If you have a pension, it’s likely that it’s invested in stocks. If it’s not invested in stocks, it should be. If you have a 401K plan, it’s invested probably somewhat in stocks. The mutual fund industry is as popular in this country as credit cards. The way the credit cards were made in the ’80s to be a people’s form of capitalism and be able to make it so that you could get a loan that you would have been denied previous, now that’s the way stocks are. Historically, stocks have not represented as big an asset class as homes. I think they’re passing homes. I think it makes sense that they pass homes. I think the idea that homes are a great investment doesn’t make sense to me, because everybody can make homes. I mean homes are very easy to build and buy. But I think that the idea of saving for stocks is a hard thing that people in this country have embraced. I think our savings rate’s much higher than Japan at this point. I think our savings rate’s much higher than Europe. I think our savings rate’s probably a highest in the country, but it’s understated by these figures.