“Rules? We don’t need no stinkin’ rules.” Many people have heard this funny line. The actual famous quote from the movie “The Treasure of Sierra Madre” was, “Badges? We ain’t got no badges. We don’t need no badges! I don’t have to show you any stinkin’ badges!”
The revised popular version is a fun variation of the original and a quote with attitude. Attitude is what I always liked about Bob Farrell. As a young stockbroker with Merrill Lynch in the late 1970s and early 1980s, I recall how we all used to look forward to Bob’s comments.
Bob was Merrill Lynch’s market analyst and commentator throughout the late 1960s and up to the early 1990s. A true legend on Wall Street, he was funny and articulate, and sometimes totally irreverent in his commentary. He retired as chief stock market analyst in 1992 but continues to write occasionally.
With all the current volatility in the stock market, and no shortage of opinions as to what is going on, I thought it might be a good time to trot out some of his best lines for your enjoyment and education. They have aged well over time and are as true today as they were when he first wrote them. Many people still quote them. “MarketWatch” gathered some of Farrell’s more famous observations, and republished them as “10 Market Rules to Remember.” With a little help from Barry Ritholtz and his blog “The Big Picture,” here are Bob’s rules.
1. Markets tend to return to the mean over time. When stocks go too far in one direction, they come back. Euphoria and pessimism can cloud people’s heads. It’s easy to get caught up in the heat of the moment and lose perspective.
2. Excesses in one direction will lead to an opposite excess in the other direction. Think of the market baseline as attached to a rubber string. Any action too far in one direction not only brings you back to the baseline, but leads to an overshoot in the opposite direction.
3. There are no new eras — excesses are never permanent. Whatever the latest hot sector is, it eventually overheats, reverts to the mean and then overshoots. Look at how far the emerging markets and BRIC nations ran over the past six years, only to get cut in half. As the fever builds, a chorus of “this time it’s different” will be heard, even if those exact words are never used. And, of course, it — Human Nature — never is different.
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways. Regardless of how hot a sector is, don’t expect a plateau to work off the excesses. Profits are locked in by selling, and that invariably leads to a significant correction — eventually.
5. The public buys the most at the top and the least at the bottom. That’s why contrarian-minded investors can make good money if they follow the sentiment indicators and have good timing. Watch Investors Intelligence (measuring the mood of more than 100 investment newsletter writers) and the American Association of Individual Investors survey.
6. Fear and greed are stronger than long-term resolve. Investors can be their own worst enemy, particularly when emotions take hold. Gains “make us exuberant; they enhance well-being and promote optimism,” said Santa Clara University finance professor Meir Statman. His studies of investor behavior show that “Losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks.”
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names. This is why breadth and volume are so important. Think of it as strength in numbers. Broad momentum is hard to stop, Farrell observes. Watch for when momentum channels into a small number of stocks.
8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend. I would suggest that even with the market rally since March 2009, we have yet to see the long drawn out fundamental portion of the Bear Market.
9. When all the experts and forecasts agree — something else is going to happen. As Bob Stovall, the S&P investment strategist, puts it: “If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?” Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.
10. Bull markets are more fun than bear markets. This is especially true if you are long only or mandated to be fully invested. Those with more flexible charters might squeak out a smile or two here and there.
So there you have it, the wisdom of Bob Farrell. Even after all these years, he still makes sense. Thanks for reading.
NICK MASSEY is a financial adviser and owner of Householder Group Financial Advisors in Edmond. Massey can be reached at www.nickmassey.com. Securities offered through Securities Service Network Inc., member FINRA/SIPC.