WWBD? What would Bob Farrell do? Part II
In First part of What would Bob Farrell do? we reviewed the first five of Bob Farrell’s legendary investment rules. Now we continue with the rules from six to ten.
Rule no. 6: Fear and greed are stronger than long-term resolution.
This rule extends rule # 5: the public buys the maximum for the top and the minimum for the bottom. Our investment rules and inherent conservatism often give way to the desire to make more money in the top spots in the market. Similarly, fear of market funds often inhibits our ability to buy assets at economic levels.
To counteract our emotions and maintain resolution, we should have a plan for different scenarios. If we can combat our feelings in the first places of the market and fulfill the risk management plans, we will have cash at our disposal to take advantage of the relative offers when the markets shrink.
Warren Buffet once said:buy when people are scared and sell when they are greedy“.
Rule no. 7: Markets are stronger when they are broad and weaker when they are reduced to a handful of blue names.
Amplitude matters! Markets are stronger when most sectors and indices are reaching highs and many stocks of the indices are also reaching highs.
Bob warns of distrust when market indices are reaching all-time highs despite many stocks not following through. The following graph shows the small size of the market that led to the financial crisis of 2008. Markets increased by about 10% until 2007, but the growing number of shares listed above 200 dma fell steadily. . Many investors ignored this signal as they were in love with the record highs.
The chart below shows that the NASDAQ (QQQ) is currently near record highs or near, but the number of shares within the index trading above their respective 200 dma is steadily declining. As they say, troops do not follow the highest leaders.
Rule no. 8: The bearish markets have three stages: a strong rebound, a reflective rebound and a fundamental downward trend.
This rule is a description of the typical path of bear markets. The most significant bear markets begin with a sharp and often unexpected fall. After the sale occurs the appearance of dip buyers. Thinking that the market will recover as it has in each previous dive, buyers take stocks at relatively cheap levels compared to previous highs.
These declines are an ideal place to reduce exposure and / or coverage if you didn’t before the initial fall in a true bear market.
The descent continues after a short break, though often at a slower pace. As the market falls, investors are increasingly consumed with fear as losses increase. Typically, a bear market ends with a capitulation sale (circle below). The following 2020 chart follows the typical three-stage bear market pattern. The following graph shows the same 1929 three-wave pattern.
Rule no. 9: When all the experts and forecasts match, something else will happen.
At its core, rule # 9 offers comfort for current opponents. Today, almost everyone seems to be on the same page as markets only going in one direction, up. Regardless of their economic opinion or valuations, most investors think the Fed has its back and will not drop prices considerably. Anything that changes the current mindset will lead to an awakening, which will result in too many sellers and too few buyers.
In the words of Sam Stovall of Standard and Poors: “if everyone is optimistic, who is left to buy? ”
In today’s environment, we see a Fed-like blind faith in bond markets. Good rubbish, for example, trades with negative real returns. It is guaranteed that investors will lose purchasing power. The only way to make a profit is if new investors are willing to accept even more negative real returns.
As we wrote in Soscavar capitalism with unrealistic values and gross distortion: “Even if we assume zero defaults, which is impossible for a bond index with gross value, investors will continue to lose money based on (real) inflation.
As they say, when everyone is on one side of the boat, go on the other side.
Rule no. 10: Stock markets are more fun than bear markets.
Of course, bullish markets are more fun. For starters, it is much easier to choose stocks in a rising market. More importantly, investors make money during stock markets. Looking like a genius and making money makes us fall in love with bullish markets.
The following graph shows the multiple emotional cycles ranging from euphoria to discouragement and back to euphoria.
Markets are currently in a phase of euphoria. While it seems easy to choose stocks and make money, we argue that this is the most difficult investment phase. The positive potential is very limited and the risks are pleasant. By contrast, the despair stage is the easiest. In the troughs of the market, valuations are the cheapest and the risk involved is relatively minimal.
Famous investor Benjamin Graham popularized the term “safety margin.” We should be more comfortable buying an asset equal to or less than its intrinsic value than paying multiples of its intrinsic value. Simply put, the amount we can go wrong is much more limited when buying a cheap asset with a “margin of safety”.
Bob’s rules are not engraved in stone like the Ten Commandments. Markets often challenge Bob’s wisdom and remain distorted up and down for long periods of time. During these periods, in which we find ourselves today, we have no choice but to ignore His wisdom. Now, more than ever, we need to follow our plan closely and have robust signals to help us face the market and also manage risks and protect them when standard 1 is demonstrated once again. .
Before you do another trade, you may want to ask yourself: WWBD?
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