Some Investment rules from a Pro

[Fransisco]

http://www.marketwatch.com/news/story/ten-investing-rules-help-you/story.aspx?guid=%7BF2637112-C05D-492A-9661-4B0E662E133D%7D&print=true&dist=printMidSection

Over several decades at brokerage giant Merrill Lynch & Co., Farrell had a front-row seat to the go-go markets of the late 1960s, mid-1980s and late 1990s, the brutal bear market of 1973-74, and October 1987's crash. Out of those and other experiences came Farrell's 10 "Market Rules to Remember."

These days, Farrell lives in Florida, and efforts to contact him were unsuccessful. Still, the following rules he advocated resonate during volatile markets such as this:

1. Markets tend to return to the mean over time

By "return to the mean," Farrell means that when stocks go too far in one direction, they come back. If that sounds elementary, then remember that both euphoric and pessimistic markets can cloud people's heads.
"It's so easy to get caught up in the heat of the moment and not have perspective," says Bob Doll, global chief investment officer for equities at money manager BlackRock Inc. "Those that have a plan and stick to it tend to be more successful."

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

Think of the market as a constant dieter who struggles to stay within a desired weight range but can't always hit the mark.
"In the 1990s when we were advancing by 20% per year, we were heading for disappointment," says Sam Stovall, chief investment strategist at Standard & Poor's Inc. "Sooner or later, you pay it back."

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

This harkens to the first two rules. Many investors try to find the latest hot sector, and soon a fever builds that "this time it's different." Of course, it never really is. When that sector cools, individual shareholders are usually among the last to know and are forced to sell at lower prices.
"It's so hard to switch and time the changes from one sector to another," says John Buckingham, editor of The Prudent Speculator newsletter. "Find a strategy that you believe in and stay put."

[Fransisco]

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

This is Farrell's way of saying that a popular sector can stay hot for a long while, but will fall hard when a correction comes. Chinese stocks not long ago were market darlings posting parabolic gains, but investors who came late to this party have been sorry.

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

Sure, and if they didn't, contrarian-minded investors would have nothing to crow about. Accordingly, many market technicians use sentiment indicators to gauge investor pessimism or optimism, then recommend that investors head in the opposite direction.
Some closely watched indicators have been mixed lately. At Investors Intelligence, an investment service that measures the mood of more than 100 investment newsletter writers, bullish sentiment rose last week to 44.8% from 37.9% the week before. Bearish sentiment slipped to 31.1% from 32.2%. Meanwhile, the American Association of Individual Investors survey was less positive, with bearish sentiment at 45.8% and bulls at 31.4%

6. Fear and greed are stronger than long-term resolve

Investors can be their own worst enemy, particularly when emotions take hold.
Stock market gains "make us exuberant; they enhance well-being and promote optimism," says Meir Statman, a finance professor at Santa Clara University in California who studies investor behavior. "Losses bring sadness, disgust, fear, regret. Fear increases the sense of risk and some react by shunning stocks."
After grim trading days like Friday's nearly 400-point tumble, coming after months of downward pressure on stocks, it's easy to think you're the patsy at this card table. To counter those insecure feelings, practice self-control and keep long-range portfolio goals in perspective. That will help you to be proactive instead of reactive.
"It's critical for investors to understand how they're cut," says the Prudent Speculator's Buckingham. "If you can't handle a 15% or 20% downturn, you need to rethink how you invest."

[Fransisco]

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

Markets and individual sectors can move in powerful waves that take all boats up or down in their wake. There's strength in numbers, and such broad momentum is hard to stop, Farrell observes. In these conditions you either lead, follow or get out of the way.
When momentum channels into a small number of stocks, it means that many worthy companies are being overlooked and investors essentially are crowding one side of the boat. That's what happened with the "Nifty 50" stocks of the early 1970s, when much of the U.S. market's gains came from the 50 biggest companies on the New York Stock Exchange. As their price-to-earnings ratios climbed to unsustainable levels, these "one-decision" stocks eventually sunk.

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

Is this a bear market? That depends on where you draw the starting line. With Friday's close, the S&P 500 Index (SPXS&P 500 Index
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SPX) is down 13.1% since its October 9 peak. Not the 20%-plus decline that typically marks a bear, but a vicious encounter nonetheless.
Where are we now? A chart of the S&P 500 shows a couple of sharp downs and subsequent rebounds in the past six months, with a tighter trading range since April. It remains to be seen if we can avoid a tortured period of the kind seen from 2000 to 2002, when sporadic rallies couldn't snap a slow, protracted decline.

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

As Stovall, the S&P investment strategist, puts it: "If everybody's optimistic, who is left to buy? If everybody's pessimistic, who's left to sell?"
Going against the herd as Farrell repeatedly suggests can be very profitable, especially for patient buyers who raise cash from frothy markets and reinvest it when sentiment is darkest.

10. Bull markets are more fun than bear markets

No kidding.

[Fransisco]

The first three really have me thinking.

Markets tend to return to the mean over time, excesses in one direction will lead to an opposite excess in the other direction, and there are no new eras -- excesses are never permanent.

There has been a lot of talk about how with commodities we have moved into a higher range, that the old highs are now the new lows. Maybe that's not going to be the case.

I still think at some point inflation is going to kick in. The question is when? Maybe it takes a couple of years, maybe only 6 months. But prices can still go lower before we get there.

Returning to the mean does not necessarily mean lower prices, it could mean going back to our old margins. Higher land and fert prices were certainly accomplishing that.

[liberty]

I remain pretty much convinced that commodity prices are going to move dramatically upwards in the future. Exactly when that will occur I don't know, but I suspect it will happen in the next six months to a year. The incredible volume of central bank credit creation over the past few months will inevitably impact on price levels.

The problem for the farming community is this: if commodity prices soar, it's also likely that the prices for farming inputs, which are often commodities themselves, will also soar. The real question going forward is not what commodity prices will be in absolute terms, but what will happen to the profit margins of those who grow them.

A period of rising commodity prices could paradoxically result in declining, not rising, profit margins for farmers. That is generally what happens in all industries during periods of inflation. People tend to only get "rich" on paper.

Having said that, I'd much rather be involved in the commodity-producing sector right now than the retail sales sector.

[Zaphod]

Excellent summary. The market always wins and those who forget or pretend otherwise get run over. Production always responds to high prices. This year, it happened faster because of good weather in a lot of places, that's all. The note about the downtrend being extended seems to make a lot of sense. Will there be bounces? Quite likely, but the market is always drawn back to the middle.

[Zaphod]

Did you notice the date on this piece -- June 11. Now go take a look at the TSX. Boy, if people (including myself) could have just been a little more cautious, we could have preserved a lot more capital. The problem with common sense is that it's not very common.

[Fransisco]

It's also not an easy thing to run against the herd. When the market is going through the roof you don't want it to end and the people telling you it's not going to last just sound like chicken little.