Bob Farrell’s 10 Rules and the Market in 2023

Banks, brokerage houses, and financial pundits are all issuing their post-mortem reflections on 2022 and looking into the new year. They will attempt to tell us what is likely for stocks, bonds, real estate, gold, and crypto for the coming year.

We will make our own attempt in due time, but we admire the effort of the financial community. We humans just don’t have reliable ways of looking into the future and there are many unpredictable variables that can influence the outcome.  So, we admire that some would stick their necks out knowing full well they could have them chopped off by unpredictable events.

Bob Farrell for many years was the chief technical analyst for Merrill Lynch. This was long before Mother Merrill got absorbed into a giant bank. As such, Farrell taught an entire generation, a generation now dying off, about how to think about markets. Over 40 years ago, we listened to his daily commentaries.

Farrell saw the benefit in what is called technical analysis. This basically is a system that subjects market price fluctuations to tools such as trendlines, moving averages, momentum indicators, sentiment indicators, and many other systems. It is based on the notion that prices are information. Further, it is based on the idea that price patterns can be helpful in predicting market movement in the future. Much like in the physical world, once price starts in one direction, it will tend to persist in that direction, at least for a while.

For technical people, price action is not random, but follows identifiable patterns and rules. In this sense, they disagree with academics that say investing is a “random walk”, and the only way to succeed is to buy and hold. No, technical people think there is a good and bad time to invest.

In some sense, this is the same as fundamental analysis which studies the economy, earnings, and accounting data in an attempt to determine if conditions are good or bad, cheap or expensive, for investing in stocks or other investments.  Fundamentalists believe that by studying the economy and companies, one can identify the good conditions to invest in and the bad conditions to avoid.  Think of Warren Buffet.

In his long years of dealing with the practical aspect of investing, Farrell came up with 10 Rules, and more recently, added one more.

There are some variations of this list one can find on the internet, but the following are from Walter Deemer, who worked alongside Farrell at Merrill for many years.

1. Markets tend to return 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. Exponentially 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. Bull 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, reflexive rebound, and a drawn-out fundamental downtrend.

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

10. Bull markets are more fun than bear markets.

Subsequent to his retirement, Farrell added one more:

11. Though business conditions may change, corporations and securities may change, and financial institutions and regulations may change, human nature remains essentially the same.

In his book, Deemer on Technical Analysis, he says:  …”what Bob Farrell’s Rules do is to elevate you past the basics; they make you think about the stock market and your investments, not just follow them via some mechanical interpretation of some rules.”

The coming year is likely to be turbulent. The FED will tighten they say until the inflation fever is broken. They are raising rates into an already slowing global economy that is badly overburdened with debt and runaway government spending. The range of possible scenarios is from the “soft landing” predicted by most, to something much more ugly on the downside. It could vary from inflation to actual deflation.

Keeping your cool won’t be easy. When stressed, consider these rules.

Deemer himself has come up with one final rule worth pondering. When it is time to buy stocks, you won’t want to.