Monday, 26 September 2011


One of the most revered investment gurus of the 1970s and 80s was Bob Farrell, who, as as chief stock market analyst at Merrill Lynch, enjoyed a front row seat during some of the biggest booms and busts of the 20th century.

Farrell's legendary status was cemented in the 1990s with the circulation of his 'market rules to remember', a list of ten simple dictums encompassing pretty much everything an investor needs to know to make money in stocks, and hold on to it.

If you haven't done so already, they're worth cutting, pasting and keeping a watchful eye on.  



1.   Markets tend to revert to the mean over time

2.   Excesses in one direction will lead to an opposite excess in the other direction

3.   There are no new eras - excesses are never permanent

4.   Exponential rapidly rising or falling markets usually go further than you think - but they do not correct by going sideways

5.   The public buys the most at the top and the least at the bottom

6.   Fear and greed are stronger than long term resolve

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

8.   Bear markets have three stages: sharp down move, reflexive rebound, drawn-out fundamental downtrend

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

10.  Bull markets are more fun than bear markets


While I could write a book on each, let me draw your attention to the rule which seems most relevant to where we sit right now - at the edge, seemingly, of the European abyss.

Yesterday, as I basked in that special glow of smugness reserved for market prognosticators who are proved spectacularly right, I passed a news stand and pulled myself up short.

The headlines screaming out from the front pages were an almost unanimous cry of doom.  Every lead story offered a variation on 'Global meltdown beckons as Greece nears default'.  

TV news bulletins on every major channel after Thursday's market bloodbath led with an item featuring some pundit in red braces jabbering about stock market 'volatility', with a chart in the background showing a line plunging from top left to bottom right and some shmuck of a trader with his head in his hands.

In short just about everyone, from the world's elite politicians, financial journalists and stock market investors to your cab driver, hairdresser and probably even your mother, now 'knows' that the clock is fast ticking down to 2008 version 2.0 if nothing is done.  

This, dear reader, is the moment we stop, take a deep breath, sink another White Russian and invoke Bob Farrell's Rule Number 9.


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


Of all Bob's truisms this, to me, is the sweetest.  Take a look at a classic recent example: the interminable debate over the US government 'debt ceiling'.  

The attention of the world bore down on US lawmakers in July as the deadline to raise the government's debt limit approached.  If the politicians failed to come to an agreement by August 2nd - an overwhelming consensus of media pundits, market mavens and politicos decreed - utter chaos would ensue and stock markets would see a massive sell-off.  So, what happened?

Halleluiah, a deal was struck before the deadline!  And stocks had a massive sell-off anyway.

Market to consensus: "Eat this."


Only a very few traders are ever positioned to take advantage of a crash before it happens.  The meltdown of autumn 2008 happened in a fog of uncertainty before the public truly cottoned on to the magnitude of what was happening, and when the consensus of the investment community was in denial, complacently believing that Lehman Brothers would be saved and something would be worked out to hold the system together.  But is ignorance or denial the problem today?  

If the consensus is now not complacent but preparing for the worst, and if Bob Farrell's dictum holds true once more, something no one quite expects is about to happen. For sure, the least likely outcome is that European leaders come to agreement in the next few days, Greece avoids default, politicians solve the debt crisis and we all go skipping off into the sunset.

But there is every chance that Greece's default will be delayed with more hand-outs until a bigger international bailout bazooka fund is agreed.  The ECB is very likely to cut interest rates at its next meeting, and it will probably open its wallet and hold down Italy's bond yields a while longer. Plus, US data is showing (very) modest signs of stabilization after we seemed earlier to be freefalling into a recession.  

In other words, authorities could eke out yet more time before the final reckoning (which I've little doubt will come).  These lulls in the action are the kinds of conditions from which bear market rallies spring.

As I showed last month, stocks have given an historic sign of technical exhaustion and are ready to bounce.  My other gauges of momentum, sentiment, breadth and volume overwhelmingly support that scenario.  In fact I suspect that - unless a Greek default happens imminently - by far the most likely outcome is the kind of multi-week or even multi-month rally nobody is looking for, beginning in the next few days.    


For these reasons I'm gradually liquidating my short positions and establishing longs at these depressed levels and below, and will buy more aggressively on upside strength from here on in.  Seeing the S&P500 up to around 1250 will satisfy my long target, while a sustained break below 1100 will be my cue to sell.