Farrell's 10 Rules

Here are Bob Farrell's official 10 rules as related by Walt:

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 a top and the least at a 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.

And Walt offers a new rule from Bob:

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

The Fable of the Fishing Boat

Then there was the time in 1978 when the bear market was taking its toll on Putnam's holdings. Walt just couldn't make the portfolio managers understand that bear markets trump even the best fundamentals.

So he circulated the following memorandum to Putnam's investment department, which he considers the best thing he ever wrote:

Once upon a time, there was a big fishing boat in the North Atlantic. One day the crew members noticed that the barometer had fallen sharply, but since it was a warm, sunny and peaceful day, they decided to pay it no attention and went on with their fishing.

The next day dawned stormy and the barometer had fallen further, so the crew decided to have a meeting and discuss what to do.

"I think we should keep in mind that we are fishermen," said the first to speak. "Our job is to catch as many fish as we can; that is what everyone on shore expects of us. Let us concentrate on this and leave the worrying about storms to the weathermen."

"Not only that," said the next, "but I understand that the weathermen are ALL predicting a storm. Using contrary opinion, we should expect a sunny day and, therefore, should not worry about the weather."

"Yes," said a third crew member. "And keep in mind that since this storm got so bad so quickly, it is likely to expand itself soon. It has already become overblown."

The crew thus decided to continue with their business as usual.

The next morning saw frightful wind and rain following steadily deteriorating conditions all the previous day. The barometer continued to fall. The crew held another meeting.

"Things are about as bad as they can get," said one. "The only time they were worse was in 1974, and we all know that was due to the unusual pressure systems that were centered over the Middle East that won't be repeated. We should, therefore, expect things to get better."

So the crew continued to cast their nets as usual. But a strange thing happened: the storm was carrying unusually large and fine fish into their nets, yet at the same time the violence was ripping the nets loose and washing them away. And the barometer continued to fall.

The crew gathered together once more.

"This storm is distracting us way too much from our regular tasks," complained one person, struggling to keep his feet. "We are letting too many fish get away."

"Yes," agreed another as everything slid off the table. "And furthermore, we are wasting entirely too much time in meetings lately. We are missing too much valuable fishing time."

"There's only one thing to do," said a crew member. "That's right!"

"Aye!" they all shouted.

So they threw the barometer overboard.

(Editor's Note: The above manuscript, now preserved in a museum, was originally discovered washed up on a desolate island above the north coast of Norway, about halfway to Spitsbergen. That island is called Bear Island and is located on the huge black and white world map on the wall in Putnam's "Trustees Room" where weekly investment division meetings took place.)

What differentiates Walt's book and sage advice is that he was on the front line -- he walked the walk in leading Putnam Management's technical analysis effort when Putnam was one of the premier money management firms extant.

I want to close by repeating what I view as my buddy/friend/pal Walt Deemer's most famous words of wisdom -- these words are always relevant, perhaps even more so in today's markets.

"When the time comes to buy, you won't want to."

-- Walt Deemer
At the time of publication, Kass and/or his funds were long GM, although holdings can change at any time.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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