By Jonathan Burton
Bob Farrell, a 90-year-old retiree in Florida, is hardly a household name on Main Street. But on Wall Street, Farrell is an absolute legend.
To say that Farrell has seen it all is an understatement. He has witnessed every bull-, bubble- and bear market since 1957, when he joined Merrill Lynch as an analyst trainee and embarked on what became a 45-year career with the firm, including a quarter-century as its high-profile chief stock-market analyst.
Farrell’s iconic 10 “Market Rules to Remember,” published in the late 1990s when he was senior investment adviser at Merrill, should be required reading for financial-industry professionals and individual investors alike.
This market-survival manifesto, its dispassionate reality a welcome antidote to Wall Street’s typically sunny salesmanship, is particularly pertinent now — with investors reminded daily that stock prices are not immune to either the forces of gravity or the fists of the Federal Reserve.
Farrell stays out of the public eye nowadays, but recently he shared his forecast for U.S. stocks in an interview with David Rosenberg , a respected veteran market strategist. Rosenberg, a former Merrill chief economist and now head of his own firm, Toronto-based Rosenberg Research , frequently references Farrell’s sobering rules in research reports that decipher market moves for institutional clients. These rules, Rosenberg says, are his “10 commandments of investing.”
In the April 27 webcast for Rosenberg Research clients, Farrell said he expects investors in U.S. stock indexes could be mauled with a 30% loss and that downward pressure on share prices could last through summer. He advises selling into rallies rather than buying dips, and otherwise sheltering in value stocks — specifically in the defense, cybersecurity, utilities and energy sectors, as well as owning gold /zigman2/quotes/210034565/delayed GC00 +0.59% and income-generating master limited partnerships.
“We are in a bear market,” Farrell said. (Rule No. 8: “Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend.”) “Growth-tech is going out of favor; we’re gradually breaking down the big-cap stocks that have kept the S&P 500 /zigman2/quotes/210599714/realtime SPX +1.06% up. By the time this is over, it’s likely that they all go into a larger decline. If the S&P 500 comes down 30%, which I think is a possibility, then you’d be down to 3,460.”
At the close on May 9, the S&P 500 was down almost 17% from its closing record high of 4,796.56 that was hit on Jan. 3.
To Farrell, the market’s current downturn is a natural consequence of the exuberant bull run that was fueled by easy money and excessive speculation. In the past couple of years especially, a fear of missing out lured many new, inexperienced buyers to stocks, lulled by a naive trust that what goes up continues to go up.
“The longer a trend persists, the more people look at the trend as permanent,” Farrell said. (Rule No. 3: “There are no new eras — excesses are never permanent.”) “That’s why investors buy the most of an asset, like stocks or bonds, at the peak in prices, and the least at the troughs.” (Rule No. 5: “The public buys the most at the top and the least at the bottom.”)
Now the pendulum is swinging back. Where it stops, nobody knows, of course, but you can confidently count on Farrell’s Rule No. 2, which states: “Excesses in one direction will lead to an opposite excess in the other direction.”
As Farrell explained in the interview: “Speculative periods are followed by an unraveling because they usually carry too far, or there’s not enough attention paid to fundamentals.” (Rule No. 4: “Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.”)
Speculation in the stock market is unraveling now but the S&P 500 /zigman2/quotes/210599714/realtime SPX +1.06% , for example, still is highly concentrated, with about 25% of its return tied to the performance of five popular, mostly technology-sector stocks.
Said Farrell: “Concentrated ownership is a cyclical measure of vulnerability or future potential, depending on how concentrated or how little a sector or group is owned.” Put another way, the U.S. stock market has been something of an inverted pyramid, a flimsy foundation that investors can and do ignore — until the pyramid topples over.
“Similar concentrations occurred in 1970-72, when the ‘Nifty Fifty’ were dominant. And in 1998-2000, when big tech was dominant,” Farrell noted. “In each of these cases, there were 10-year down cycles [after the collapse] in the concentrated leaders.”
The biggest and best-loved stocks falling hardest underscores Farrell’s Rule No. 7, which states: “Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.” It also harkens to Rule No. 9: “When all the experts and forecasts agree — something else is going to happen.”
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For the bulls to regain control, Farrell said he would watch for evidence of capitulation by investors — selling pressure and big down days, in other words, that sets up a lasting advance. (Rule No. 6: “Fear and greed are stronger than long-term resolve.”) Going forward, Farrell expects value stocks, gold, utilities and energy to emerge as the new market leaders, at least for the near-term, and for the major U.S. stock indexes overall to provide below-average returns. (Rule No. 1: “Markets tend to return to the mean over time.”)
Many index-fund holders will be disappointed if this comes to pass, of course, so Farrell encourages investors to add more active management to their portfolio. Said Farrell: “We’re going from a period where the best money was made being in an index fund to a period where you make money identifying the right individual stocks and sectors. I’d concentrate more on that.” (Rule No. 10: “Bull markets are more fun than bear markets.”)