Legendary Merrill Lynch market strategist Bob Farrell developed a list of 10 rules of investing that remain heavily quoted more than 20 years after he retired. Stephen Suttmeier, technical research strategist at Merrill Lynch successor BofA Securities, released a report in late May reviewing Mr. Farrell’s investing rules for guidance in the current market.
The 10 rules are:
- Markets tend to return to the mean over time.
- Excesses in one direction will lead to opposite excess in the other.
- There are no new eras.
- Exponential rapidly rising or falling markets usually go further than you think but they do not correct by going sideways.
- The public buys the most at the top and the least at the bottom.
- Fear and greed are stronger than long-term resolve.
- Markets are strongest when they are broad and weakest when they narrow to a handful of blue chip names.
- Bear markets have three stages: sharp down, reflexive rebound, and a drawn-out fundamental downtrend.
- When all the experts and forecasts agree – something else is going to happen.
- Bull markets are more fun than bear markets.
In terms of mean reversion, Mr. Suttmeier outlined that the S&P 500 tends to revert to the 200-week moving average during bear markets, which would imply a 14 per cent decline from current levels. He also believes bond yields will return to somewhere near the long-term average, which would be 4.7 per cent for the U.S. 10-year Treasury.
I suspect that many readers were thinking about the domestic housing market when they read Mr. Farrell’s investing rules. Housing prices have been increasing at a rate well beyond long-term trends.
Mike Moffatt, assistant professor at the Ivey Business School, estimates that southern Ontario housing prices, for example, are between 20 per cent and 30 per cent higher than population growth trends would imply. Rule number one then suggests that these residential markets are set for a decline of that proportion. The second investing rule would mean southern Ontario home prices would fall much further – ‘opposite excess’ - before rallying.
Mr. Suttmeier uses a number of previous boom and bust cycles – Japan’s Nikkei index in the 1980s, the tech bubble, the pre-financial crisis U.S. housing bubble, bitcoin and FANG stocks more recently – to support Mr. Farrell’s rule number four.
In each case, an exponential rally was corrected by an almost equally massive decline. Rule number three, then, advises against trying to buy the dips in previously top performing market sectors like technology.
Rule number eight, covering the three stages of a bear market, provides an important frame of reference for equity investors in the coming weeks. The S&P 500 fell 19 per cent – one percentage point short of an official bear market- from the January peak to the May 22 low. It has rallied about five per cent since.
I am not yet convinced a bear market has begun. But, if the current rally fades into a slow grind lower for equities, I would be much more inclined to heed the warning of Mr. Farrell’s rule eight.
Mr. Farrell’s rules are timeless and worth reviewing regularly to maintain investment discipline.
-- Scott Barlow, Globe and Mail market strategist
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Ask Globe Investor
Question: Given that rising rates are adversely impacting bonds, what is your opinion on holding the Mawer Balanced Fund (MAW104.CF) with its 30-per-cent bond exposure? – David D.
Answer: This fund has had a good long-term record. As of March 31, the 10-year average annual compound rate of return was 8.7 per cent, which puts it near the top of its category. Morningstar gives it a four-star rating.
That said, it is going through a rough period right now and the 30 per cent bond exposure is not helping. The fund lost 7.7 per cent in the first quarter and almost certainly dropped more in April/May (Mawer publishes returns quarterly).
If you own the fund, I’d hang in because the long-term record says it will recover. But I would not commit new money at this time.
--Gordon Pape. (Send questions to email@example.com and write Globe Question in the subject line.)
What’s up in the days ahead
Rob Carrick this weekend looks at how much money many investors will save with a prohibition that became effective this week on selling funds with trailing commissions.
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Compiled by Globe Investor Staff