Legendary Merrill Lynch market expert Bob Farrell developed a list of 10 investing rules that are still highly quoted more than 20 years after his retirement. Stephen Soetmeyer, technical research strategist at Merrill Lynch’s successor BofA Securities, released a report in late May reviewing Farrell’s investment rules for guidance in the current market.
The ten rules are:
- Markets tend to return to the mean over time.
- Increases in one direction will lead to an opposite excess in the other.
- There are no new ages.
- Usually bullish or bearish markets quickly go further than you think but they do not correct by going sideways.
- The public buys more at the top and less at the bottom.
- Fear and greed are stronger than long-term resolve.
- Markets are stronger when they are broad and weaker when they are limited to a few excellent names.
- Bear markets are characterized by three phases: a sharp decline, a reversal recovery, and a long-term primary downtrend.
- When all experts and predictions agree – something else will happen.
- Bull markets are more fun than bear markets.
In terms of average retracement, Mr. Suttmeier explained that the S&P 500 tends to return to the 200-week moving average during bear markets, implying a 14 percent drop from current levels. He also believes that bond yields will return to somewhere near the long-term average, which would be 4.7 percent for the 10-year US Treasury.
I suspect many readers were thinking about the local housing market when they read Mr. Farrell’s investment rules. Home prices have risen at a rate that far exceeds long-term trends.
Mike Moffat, associate professor at the Ivy School of Business, estimates that home prices in southern Ontario, for example, are between 20 percent and 30 percent higher than population growth trends might suggest. Then the first rule indicates that these residential markets are set for a decrease in this percentage. The second investment rule will mean that home prices in southern Ontario will fall much more – the “adverse surplus” – before rising.
Mr. Suttmeier uses a number of past boom and bust cycles — the Japanese Nikkei in the 1980s, the tech bubble, the US housing bubble before the financial crisis, and bitcoin and FANG stocks more recently — to prop up Farrell’s rule number four.
In each case, the exponential rise was corrected by an almost identically large decrease. The third rule, then, advises against trying to buy dips in previously top-performing market segments such as technology.
Rule number eight, which covers the three phases of a bear market, provides an important frame of reference for stock investors in the coming weeks. The S&P 500 is down 19 percent – one percentage point lower than the official bear market – from its January peak to its May 22 low. It has risen about five percent since then.
I’m not yet convinced that a bear market has started. But, if the current rally fades into a slow decline in stocks, I’d be more inclined to heed Farrell’s Eighth Rule warning.
Mr. Farrell’s rules are timeless and worth reviewing regularly to maintain investment discipline.
— Scott Barlow, Market Strategist, Globe and Mail
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However, it is going through a rough time right now and offering a 30 per cent bond isn’t helping. The fund lost 7.7 percent in the first quarter and almost certainly fell further in April/May (Mauer posts quarterly returns).
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