No, we are not referring to the 1991 full-length feature comedy where a needy patient, played by Bill Murray, tracks down his therapist (Richard Dreyfuss) – who is on vacation with his family – overstays his welcome and drives his doctor insane.
To many, the name Robert Farrell may not mean much; however, in professional investing circles, Bob is a legend. Why so? After studying fundamental analysis at Columbia University under the venerable Benjamin Graham and David Dodd – aka Graham and Dodd – Bob was hired in the late 1950s into the analyst training program at Merrill Lynch. By 1959, he was named the firm’s technical analyst, a senior role. Over his nearly 50-year career at Merrill, his work pioneered little-known areas of investor sentiment (i.e., market psychology) and technical analysis, otherwise known as studying the charts of stock prices to discern patterns. Having a front-row seat to every bull and bear market since the late 1950s created the context for his seminal work, “10 Market Rules to Remember,” which was published in the late 1990s and that, in our opinion, is timeless. These “rules” are sometimes forgotten by investors and require revisiting periodically, especially now, given the current state of stock markets here in the U.S. and globally.
In this quarterly report, we will highlight three of Bob’s rules.
Using the chart above, which shows the price of the S&P 500, we can see a clear example of Bob’s rule 8 in action. Late 1999 was the peak of the technology sector, as valuations were reaching eye-popping levels. This bear market followed rule 8 rather closely, as mapped out by the green lines on the chart. A sharp down leg from September 2000 to April 2001, a reflexive rebound, followed by a drawn-out fundamental downtrend (punctuated by a sharp downturn after September 11, 2001) that finally ended in March 2003. Forming a market bottom is a process and it is interesting to note how the S&P 500 looked like it made a “bottom” in August 2002, only to retest that mark in October 2002 and put in a final bottom in March 2003. The stock market is a mechanism that is continually discounting the future and, as new information becomes available, will adjust accordingly.
The above chart, courtesy of J.P. Morgan Asset Management, plots the weight of the top 10 stocks by market capitalization in the S&P 500. As of June 30, 2022, those companies were: Apple, Microsoft, Amazon, Tesla, Google, Berkshire Hathaway, United Health, Johnson & Johnson, Nvidia and Meta. After nearly reaching an all-time high of 32% weight of the S&P 500, the top 10 have receded to 28% so far this year. However, even at present levels, the weight is higher than the technology peak more than 20 years ago. Given the current situation that exists, according to this rule, the S&P 500 may not be in a particularly strong position at this point in the cycle as its future direction is heavily dependent on the top 10.
The above New York Magazine cover appeared in April 2021, during a period where several excesses were present, at least in our opinion. Special Purpose Acquisition Companies (blank check companies) were very popular and viewed as a “new” way to bring a company public. Non-Fungible Tokens (digital art) were all the rage and considered a “new” art form. Meanwhile, cryptocurrency Bitcoin made an all-time high as a “new” era of money was entering the mainstream. As rule 3 states, these excesses are not permanent and seem to be in the process of correcting themselves in 2022.
The tough markets year to date have not only professional investors but also individuals looking for reliable rules of the road to follow. Bob Farrell’s rules may fit that bill for many. As handy as these rules can be, at Forza, we continue to keep a keen focus on individual stock valuations, with a preference for profitability and shareholder friendliness in the form of dividends and share repurchases.