Rules to Remember

I worked at Merrill Lynch a number of years ago in the Equity Research department. The Chief U.S. Economist at the time was David Rosenberg, a very savvy and well-respected analyst on the Street. He would from time to time share “10 Market Rules to Remember” created by Bob Farrell, a former chief stock market analyst at the firm who retired in the 1990s.

While going through some old notes and files last night, I came across these rules and revisited them. There is certainly a lot of wisdom for anybody with an interest in investment markets.

1. Markets tend to return to the mean over time.
2. Excesses in one direction will lead to an opposite excess in the other direction.
3. There are no new eras – excesses are never permanent.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
5. The public buys the most at the top and the least at the bottom.
6. Fear and greed are stronger than long-term resolve.
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
8. Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend.
9. When all experts and forecasts agree – something else is going to happen.
10. Bull markets are more fun than bear markets.

Short-term Thinking

I have been thinking a lot about market direction from here and trying to balance the commentary coming from many well-respected and highly successful investors. There has been a lot of caution across channels as this market cycle matures. Based on much of the commentary I have been exposed to, it would appear we are due for a major market correction at some point in the next few years. Given the perception that valuations are excessive, Bob Farrell’s Rules 1, 2 and 3 would currently be applicable. However, it sure feels like there are a lot of experts warning and cautioning against the inevitable market collapse. See Rule 9. “All” experts and forecasts don’t currently agree but the warning camp appears to be much more prominent than the bull camp right now.

I read a piece in the Financial Times this morning from yesterday’s edition called, Beware the plastic bears who dishonestly peddle market doom. It’s a thought provoking piece on short-term thinking and predictions. A few excerpts that I particularly liked were the following:

“Short-term thinking and market timing are the enemies of successful investing.”

“Predicting the future with any sort of reliability is impossible…”

The piece addresses the “thoughtless bearishness” of many investment professionals on the buy and sell sides, stating that analysts and commentators are incentivized to have pessimistic market opinions in the post Financial Crisis world. Admittedly, I am suffering from confirmation bias here as I hold the same opinion as the author. However, market commentary has generally been quite pessimistic since the market troughed in early 2009 while the market has increased nearly four-fold.

There will obviously be a market correction at some point in the future. Nobody knows with surety when that will be. Caution is a key characteristic of any successful investor, but like everything else in life it must be balanced and used in moderation.