财经观察 1637 --- Merrill’s Rosenberg Inspired by Farrell in Foresee

10 Market Rules to Remember - Bob Farrell

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. 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 - reflexive rebound - a 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

-  Bob Farrell was MER's Market Strategist for 40 years achieving almost legendary status. He is now retired but continues to opine on the markets.

 

My Personal Extrapolation:  Rule 8, Bear markets have three stages - sharp down - reflexive rebound - a drawn-out fundamental downtrend, to me, was the most important rule throughout '08 where investors were continually tempted to buy the bear-market-equity-rallies.  I believe '09 might best be characterized by Rule 4:  Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways. 

The S&P 500 is up 19% from the November 20th lows and looks poised to rally into early '09.  As employment, corporate earnings, and global GDP continue to deteriorate throughout most of next year, I would expect the major indices to give back everything they have recently gained, breaking through the previously set lows.  One must not forget that corporations, individuals, countries, and municipalities still have significant debt burdens, accumulated throughout this entire credit expansion.  This debt must be addressed before a full-on recovery will ensue.  Excess capacity will be addressed through bankruptcy and further consolidation.

The cash currently on the sidelines will be invested in Distressed, HY & IG Credit during the first few months of '09 as these markets have done a better job pricing-in this recession.  

Equity markets will follow the credit markets as so often is the case.  All of this will take time.

The silver-lining might just be that the beginning stages of a recovery will occur at some point in late late '09?  Might '09 be earmarked as a recovery year?  Time will tell.

 

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The most read article on Bloomberg News yesterday: 

Merrill’s Rosenberg Inspired by Farrell in Foreseeing Crash  -  Bloomberg Article  -  By Carlos Torres 

 

David Rosenberg drew on inspiration from market-rules theorist Robert Farrell and asset-bubble historian Charles Kindleberger to predict the economy’s demise this year.

Rosenberg, the chief North American economist at Merrill Lynch & Co. in New York, by January had already called the recession that this month was officially declared to have started in December 2007. He also said the Federal Reserve would lower its main interest rate to 1 percent by year-end, one-third of the median estimate of economists surveyed by Bloomberg News; by October, policy makers brought the rate to that level.

Rosenberg, 48, refused to trust his computer models, sensing that the end of the credit and housing-market booms would cause a deeper rout than most analysts thought. Now, he predicts the carnage will cause a 2.5 percent contraction in gross domestic product in 2009, and sees historians calling the current era “GDII,” a reference to the Great Depression. “We came off a prolonged period of prosperity that was fueled by excessive leverage and an asset bubble of historical proportions,” Rosenberg said in an interview. “Either you believed that this was sustainable or you didn’t. I came to the conclusion that this was going to end very badly.” Rosenberg, a former Bank of Canada economist, projected in January that the U.S. economy would expand 1.6 percent this year, compared with a median estimate of 2.1 percent in a Bloomberg survey of 64 analysts. By the end of that month, he cut his forecast by more than half.

‘Key Metric’     It all came down to the premise that the downturn in housing was going to have a lagged and severe impact on everything from economic growth to interest-rate spreads and stocks. Personal savings, Rosenberg’s “key metric,” would head higher as Americans tried to repair tattered finances resulting from the slumps in property values and stock prices.

That’s where Rosenberg differed from the majority in his profession, who he said were using terms like “contained” to describe the impact of the subprime mortgage crisis, or “resilient” when talking about consumer spending, which had risen for a record 17 years. “You have to have your models, but you have to question the results,” Rosenberg said. “You have to ask yourself: Where could the model be wrong this time? Bubbles go further than you think, but they do not correct by going sideways,” he said, quoting the fourth of “10 Market Rules to Remember,” by former Merrill analyst Farrell.

Farrell’s Rules 

Farrell developed his “10 Market Rules” during a 25-year stint as chief strategist at Merrill until 1992. He won Institutional Investor magazine’s award for overall stock market direction in 16 of 17 years, according to a Dec. 19, 1992, New York Times article. Rules one through four, which include the belief that markets always return to long-run averages and excesses in one direction are invariably followed by excesses in the opposite direction, are applicable to this decade’s housing cycle, Rosenberg said. Farrell’s rules “were a compass in terms of guiding me through the past three years,” said Rosenberg, who joined Merrill in 2000 and holds master’s and bachelor’s degrees in economics from the University of Toronto. Rosenberg will remain at Merrill after Bank of America’s takeover of the New York-based securities firm is completed on Jan. 1, according to spokeswoman Elana Mehas.

Kindleberger’s Manias 

Kindleberger, the late economic historian who taught for 33 years at the Massachusetts Institute of Technology, is famed for his 1978 book “Manias, Panics and Crashes.” The work traced four centuries of boom-and-bust cycles, bringing to light a 17th century frenzy over Dutch tulips that sent investors offering land, houses, farm animals and gold in return for choice bulbs. The severity of today’s housing bust, and the resulting collapse in credit, indicate that the U.S. won’t soon emerge from the already yearlong recession, according to Rosenberg. “What we know about periods of asset deflation and credit contraction is that the impact on the economy tends to last for years not quarters,” he said, projecting housing is likely to contract through the end of 2009. Rosenberg was also among the few predicting a rally in U.S. Treasuries, which have posted their best year since 1995. The average forecast in a Bloomberg survey of 61 analysts at the start of the year was for benchmark 10-year yields to rise to 4.32 percent for the end of December. Rosenberg’s call was 3.70 percent; the lowest projection was 3.5 percent.

Treasuries Rally

Still, none of the group predicted the panic buying that drove yields to 2.04 percent this month, the lowest level since daily records began in 1962. Three-month T-bill rates turned negative this month as some investors in effect paid the government to keep their money.

Rosenberg has long been more pessimistic than the consensus on the economic outlook. That hurt his accuracy when the economy was doing better. He came in the bottom 10th in a Bloomberg analysis of the accuracy of 55 forecasters on GDP, inflation, unemployment and Fed rate decisions for 2006 to mid-2008. In the stock market, too, few prognosticators foresaw the depth of the decline this year, when the Standard & Poor’s 500 Index tumbled 40 percent, the worst annual retreat since 1931, and $29 trillion was erased from the value of equities worldwide. Just six of the 1,611 U.S. mutual funds that invest in stocks and have more than $250 million in assets gained in 2008, according to data compiled by Bloomberg. Among them is Grantham Mayo Van Otterloo & Co.’s $2.04 billion GMO Alpha Only Fund, which returned 12 percent.   

For his part, Rosenberg sees gold as “an important hedge against policy missteps” in the global recession of 2009. “The chart looks good against a vast majority of currencies,” he wrote in a Dec. 22 research note.  

Bob McCann, the Head of MER Global Wealth Management hosted a panel with both Bob Farrell (former ML Chief Market Analyst) and Chuck Clough (former ML Senior Investment Strategist).  

The market experience of these two men is over 80 years collectively.  The below remarks should be read, and read carefully.

Bob Farrell

 

"capitulation is the market's way of reminding us that emotion is more powerful than reason"

 

"news doesn't make the market, the market makes the news"

 

Farrell has been analyzing markets for over 50 years and has never seen anything like this - lived through 1962/ 1971/ 1980/ 1987 and 2001 corrections but this is unprecedented.  Have to go back to 1930's to find something similar.

 

We are experiencing a secular adjustment that began in '00.  Have had excesses in tech/ housing/ financials/ commodities that we are now correcting.

 

Secular bear markets take us from extreme overvalued levels to extreme undervalued levels.  Other secular bear markets Bob pointed to: 1929-1942/ 1968-1982/ Japan in the '90s. most last 13-14 years.

 

We are in the latter stages of the first parabolic move to the down side and are seeing capitulation. market give up of 15% in 1/2 day (thurs afternoon (10/9) into friday morning (10/10)was significant. expects October to mark a near term bottom (October generally a "bear killer" month).   Potential for a re-test/ undercut of the lows later this year or early in 2009. Bob does not think we break 2002 lows (SPX 768).

 

Best time to buy stocks is not in this time of heightened volatility.  After bottom is put in place, there will be a period characterized by "disinterest" when volumes go dead and no one wants to be involved in equities.  Buy stocks aggressively at this stage.

 

It will take many years before we are back into a secular bull period like 1940's and 1950's or 1980's and 1990's.  After we put bottom in place in coming months, expect us to retrace about 1/2 of what market just lost before consolidating again.   Don't look for new leadership - new market leadership will be established during the market's consolidation period.

 

The Nasdaq in this decade mirrors the pattern of the Dow in the 1930's. Nasdaq in 2000 was the Dow in 1929.

 

Within bear markets, there are always opportunities to make money.   In the Japanese bear maket of the 1990's, Sony went up 3x.  In markets like this, stock picking is paramount and the marketplace needs the sell side's help more than ever.

 

Chuck Clough

 

Deflation is real risk in this economy.  Shocked by central bankers infatuation with inflation.

 

Corporate sector is the net saver this cycle.  Big cash positions across board, especially in tech and retail.

 

Current account balance simply defined as measure of savings vs . investment.  Excess investment relative to savings leads to weak currency and vice versa.    As savings rate in US inevitably goes higher so will currency,  there is no surprise the dollar is rallying.

 

Short term rates are on the way to 0 as banks consolidate and bid down the cost of deposits taking the whole curve lower.  Cash will be left looking for yield and equities will be one of the few places to find it.  Bullish for stocks longer term.

 

Look for stocks with compounding free cash flow (little investment need over next few years) ie. coal names

 

Look for opportunities to play consumer growth in the emerging markets.   Cloug echoed Michael Hartnett's sentiment that emerging markets consumer is where US consumer was in late '80's and early '90's.

 

 

In addition to Farell's 10 Market Rules to Remember (below),  I add one from mathematician John Allen Paulos:  "Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security,"  

 

I bring your attention to one of my Farell favorites,  Rule 8.  'Bear markets have three stages - sharp down - reflexive rebound - a drawn-out fundamental downtrend.'   The cycle that began in October of '07 will continue to repeat over and over again thru the next year:  the sharp down yesterday will eventually be followed by a reflexive rebound and ultimately, another drawn-out fundamental downtrend.  The fundamental downtrend will be the demise of consumer spending, higher unemployment, further credit card losses,  and of course a consumer led recession.  The only cure is duration.   Is Rosenberg's 756 Target for the S&P 500 unreasonable?

If there is anything that I can help with in this environment, please let me know.  I am always at my post.