Breaking News
Get Actionable Insights with InvestingPro+: Start 7 Day FREE Trial Register here
Investing Pro 0
Ad-Free Version. Upgrade your Investing.com experience. Save up to 40% More details

Bob Farrell's 10 Timeless Rules On Investing - Part 2

By Michael LebowitzMarket OverviewAug 19, 2021 01:01AM ET
www.investing.com/analysis/bob-farrells-10-timeless-rules-on-investing--part-2-200599318
Bob Farrell's 10 Timeless Rules On Investing - Part 2
By Michael Lebowitz   |  Aug 19, 2021 01:01AM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items
 

In Part 1 of What Would Bob Farrell Do? we reviewed the first five of Bob Farrell’s legendary rules of investing. We now continue with rules six through ten.

6. Fear and greed are stronger than long-term resolve

This rule extends rule 5 - the public buys the most at the top and the least at the bottom. Our investment rules and inherent conservatism often yield to the yearning to make more money at market tops. Similarly, fear at market bottoms frequently inhibits our ability to buy assets at cheap levels.

To counteract our emotions and maintain resolve, we should have a plan for different scenarios. If we can fight our feelings at market tops and adhere to risk management plans, we will have cash on hand to take advantage of relative bargains when markets bottom.

Warren Buffet once said, “buy when people are fearful and sell when they are greedy.”

7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names

Breadth matters! Markets are strongest when most sectors and indexes are hitting highs, and many stocks within the indexes are also hitting highs.

Bob warns to be wary when market indexes are hitting all-time highs despite many stocks not following. The graph below shows the market’s poor breadth leading into the 2008 Financial Crisis. Markets rose by about 10% through 2007, yet the increasing number of stocks trading above their 200 dma fell steadily. Many investors ignored this signal as they were enamored with record highs.

The following graph shows the NASDAQ (QQQ) is currently at or near record highs, yet the number of stocks within the index trading above their respective 200 dma is steadily falling. As it is said, the troops are not following the leaders higher.

8. Bear markets have three stages – sharp down, reflexive rebound, and a drawn-out fundamental downtrend

This rule is a description of the typical path of bear markets. Most significant bear markets start with a sharp and often unexpected decline. Following the sell-off comes the emergence of dip buyers. Thinking the market will bounce back as it has done on each prior dip, buyers scoop up shares at what appear relatively cheap levels compared to previous highs.

These dips are a great place to reduce exposure and/or hedge if you did not before the initial drop in a true bear market.

The decline continues after the brief respite, albeit often at a slower pace. As the market falls, investors are increasingly consumed with fear as losses mount. Usually, a bear market ends with a capitulation sell-off (circle below). The following graph from 2020 follows the typical three-stage bear market pattern. The following chart shows the same three wave pattern from 1929.

9. When all the experts and forecasts agree – something else is going to happen

At its core, rule #9 offers comfort for today’s contrarians. Today, almost everyone seems to be on the same page that markets only go in one direction, up. Regardless of their economic opinion or valuations, most investors think the Fed has its back and will not let prices drop appreciably. Anything that changes the current mindset will result in a rude awakening, resulting in too many sellers and too few buyers.

In the words of Sam Stovall from Standard and Poors: “if everybody’s optimistic, who is left to buy?”

In today’s environment, we see a similar blind faith in the Fed in the bond markets. Junk bonds, for instance, are trading with negative real yields. Investors are all but guaranteed to lose purchasing power. The only way to profit is if new investors are willing to accept even more negative real yields.

As we wrote in Undermining Capitalism with Unreal Values and Crass Distortion: “Even if we assume zero defaults, which is impossible for an index of junk-rated bonds, investors will still lose money on an inflation-adjusted (real) basis.”

As it is said, when everyone is on one side of the boat, go to the other side.

10. Bull markets are more fun than bear markets

Of course, bull markets are more fun. For starters, it is much easier to pick stocks in a rising market. More importantly, investors make money during bull markets. Looking like a genius and making money enamors us to bull markets.

The graph below shows the multiple emotional cycles ranging from euphoria to despondency and back to euphoria.

Markets are currently in the euphoria stage. While it seems easy to pick stocks and make money, we argue this is the most challenging investment stage. The potential upside is greatly limited, and the risks are palatable. Conversely, the despondency stage is the easiest. At market troughs, valuations are the cheapest, and the risk involved is relatively minimal.

Famed investor Benjamin Graham made the term “margin of safety” popular. We should be more comfortable buying an asset at or below its intrinsic value than paying multiples of its intrinsic value. Simply, the amount we can be wrong is much more limited when buying a cheap asset with a “margin of safety.”

Summary

Bob’s rules are not etched in stone like the ten commandments. Markets often defy Bob’s wisdom and stay distorted on the upside and downside for long periods. During such periods, as we are currently in, we do not have the option of ignoring his wisdom. Now, more than ever, we must closely follow our plan and have sturdy signals in place to help us ride up with the market yet manage risk and protect when Rule 1 proves true once again.

Bob Farrell's 10 Timeless Rules On Investing - Part 2
 

Related Articles

Bob Farrell's 10 Timeless Rules On Investing - Part 2

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Continue with Google
or
Sign up with Email