While I am not a fan of most big firm fundamental analysts, over the years, Merrill Lynch has had some sharp guys in their Chief Strategist/Economist positions.

Here are some lessons and rules from 3 of them.

Richard Bernstein was “notoriously cautious on stocks for much of this decade” — and was very bearish on the financials in 2007-08. Once BofA took over Merill, Bernstein moved on to greener pastures.

Here are his 10 “Market Lessons.”

Richard Bernstein’s Lessons
1. Income is as important as are capital gains. Because most investors ignore income opportunities, income may be more important than are capital gains.
2. Most stock market indicators have never actually been tested. Most don’t work.
3. Most investors’ time horizons are much too short. Statistics indicate that day trading is largely based on luck.
4. Bull markets are made of risk aversion and undervalued assets. They are not made of cheering and a rush to buy.
5. Diversification doesn’t depend on the number of asset classes in a portfolio. Rather, it depends on the correlations
between the asset classes in a portfolio.
6. Balance sheets are generally more important than are income or cash flow statements.
7. Investors should focus strongly on GAAP accounting, and should pay little attention to “pro forma” or “unaudited” financial
statements.
8. Investors should be providers of scarce capital. Return on capital is typically highest where capital is scarce.
9. Investors should research financial history as much as possible.
10. Leverage gives the illusion of wealth. Saving is wealth.

Well before the economy crumbled last fall, David Rosenberg was one of the few mainstream economists who had been warning — for years — that the U.S. faced a day of reckoning from heavy borrowing to sustain spending. Here are Rosie’s Rules to Remember (an economist’s dozen):

David Rosenberg’s Lessons
1. In order for an economic forecast to be relevant, it must be combined with a market call.
2. Never be a slave to the data – they are no substitutes for astute observation of the big picture.
3. The consensus rarely gets it right and almost always errs on the side of optimism – except at the bottom.
4. Fall in love with your partner, not your forecast.
5. No two cycles are ever the same.
6. Never hide behind your model.
7. Always seek out corroborating evidence
8. Have respect for what the markets are telling you.
9. Be constantly aware with your forecast horizon – many clients live in the short run.
10. Of all the market forecasters, Mr. Bond gets it right most often.
11. Highlight the risks to your forecasts.
12. Get the US consumer right and everything else will take care of itself.
13. Expansions are more fun than recessions (straight from Bob Farrell’s quiver!).

Bob Farrell was considered the best strategist on Wall Street, and while he still pens a stock market letter, his “lessons learned,” written back then, are as timeless today as they were in 1992.

Bob Farrell’s 10 Lessons
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 rising and falling markets usually go further than you think.
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-chips.
8. Bear markets have three stages.
9. When all the experts and forecasts agree – something else is going to happen.
10. Bull markets are more fun than bear markets.

Hat tip Jeff Saut

Category: Apprenticed Investor, Investing, Markets, Rules

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

25 Responses to “Lessons from Merrill Lynch”

  1. keithpiccirillo says:

    Great ironic advice, but I notice a subprime/CDO number avoidance which lies at the heart of their failure.
    Maybe #2?

  2. Marcus Aurelius says:

    From The Onion:

    President Obama To Win Back U.S. Debt From Chinese In Double-Or-Nothing Card Game

  3. cognos says:

    Uh, Farrell seems to smoke both Bernstein and Rosenberg (what an awful record Rosi has).

    Bernstein — “Savings is wealth, not leverage”. That’s funny. Most of the ultra-wealthy I know have been very levered at the right time (when nobody else, esp forecasters like Bern, Rosenberg wanted to be).

    How much wealth has been created by “saving” into safe interest bearing accounts? Very little and in fact most wealthy fortunes are destroyed this way over time. Taking NO risk = slow, poor results. In fact, it results in you chasing performance when you realize your mistake after a few years at 2%… when everyone else has already made money… exactly the wrong time.

    The right thing to have is leverage to hard work and invention in your own business, OR leverage to your intelligence/training in the right field, OR leverage to smart investments after mild or serious downturns.

  4. TDL says:

    Great list BR. I would extend Richard Bernstein’s 1st lesson, “1. Income is as important as are capital gains. Because most investors ignore income opportunities, income may be more important than are capital gains.”, to entrepreneurs and high risk job seekers as well. The hoped for outcome is less important than generating income/revenue now.

    Regards,
    TDL

  5. Bill in SF says:

    Re: Rosenbergs No. 4:

    “Fall in love with your partner, not your forecast.”

    I ask my neighbor to explain how he makes such wise investment decisions. He said:

    “My wife’s a nagging indicator.”

  6. ToNYC says:

    ToNYC’s Lessons

    1. Never add to a Losing Trade.
    2. Never let a good story allow you violate Lesson 1.
    3. Better to think about selling first; that’s the hardest part of the trade.
    3. Keep pressing the winners; buy OTM options to hedge rather than stops.
    4. Losers and the length of time spent in them are just tuition in trader college.
    5. Be grateful for mistakes that illustrate your state of knowledge.

  7. Robespierre says:

    6. Balance sheets are generally more important than are income or cash flow statements.
    7. Investors should focus strongly on GAAP accounting, and should pay little attention to “pro forma” or “unaudited” financial
    statements.
    8. Investors should be providers of scarce capital. Return on capital is typically highest where capital is scarce.

    Based on 6, 7 and 8 no bank was a good investment back in March of 2009. O yeah I forget markets are not being manipulated…

  8. martin66 says:

    Farrell has it all over Bernstein and Rosenberg though Bernstein’s #10 seems particularly relevant today. Curious how Farrell would have defined the three stages of a bear market.

  9. cognos says:

    One commenter likes: “Never add to a losing trade”.

    I’ll take the opposite of that… “Never add to a big winning trade” and always look for good recent losers to add to. Most great trade go against you at many points… that exactly when you want to be adding no?

    I want to be (and was) adding to stocks in Nov 08 and Mar 09.

  10. investorinpa says:

    Cognos has it 100% right…Rosenberg’s track record is PATHETIC, esp in the past 9 months. He is even worse than Doug “Hey, I got one right when I called a bottom!” Kaas, who told everyone the market was gonna correct 1000 points on the Dow ago!

    I still don’t get why someone like Barry or Mish Shedlock bothers to keep posting stuff by Rosenberg. My goodness, rule 8 about having respect for what the market is telling you is completely being ignored by Rosie! Yes, Rosenberg WRITES well (meaning he has a good command of the English language), but his calls/predictions are so bad. At least a guy like Peter Schiff who decried the dollar told his investors to put money into gold & international investments, which at least made good returns. Rosenberg would have us all build a cocoon, order a survival kit from Costco, and hoard supplies!

  11. DL says:

    “Never add to a losing trade”

    I’ve always had a problem with that.

    Suppose there are two investors, each with $100K to invest.

    Investor #1 puts $5000 into financial instrument “X”, and it promptly falls in value by 10%. He then puts in another $5000; it falls another 10%. Finally, he puts in another $10,000, and it begins to turn around; he ends up with a nice profit in the end.

    Investor #2 puts the whole $100K down on financial instrument “X”; after it has dropped 5%, he gets out, and never gets back in.

    In my opinion, investor #1 is much better off. Not only does he wind up with a profit, but his drawdown is very small relative to his portfolio size.

  12. Mannwich says:

    I would add: “do not overthink “the market”" or whatever you call what we this thingy is nowadays. It often pays to do seemly stupid things in this environment. Fundamentals and the underlying companies “the market” is supposed to represent don’t matter 99% of the time until they one day do.

  13. wunsacon says:

    Probably no one on here thinks anyone one of these bullet points should be applied 100%. We consider them “notes of caution” or “things to think about” each time you’re asking yourself whether to go long, go short, or go neutral (which is also a decision).

  14. Tom K says:

    “Never add to a losing trade”

    Good advice. As Paul Tudor Jones put it: “Losers average losers.”

  15. km4 says:

    George Carlin ~ The American Dream
    http://www.youtube.com/watch?v=acLW1vFO-2Q&feature=player_embedded#

    Carlin was absolutely right. They gave it all to Wall street, just like he said would happen.

    The game is rigged and nobody seems to notice. Nobody seems to care. Good honest hard-working people . . . white collar, blue collar it doesn’t matter what color shirt you have on. Good honest hard-working people continue, these are people of modest means . . . continue to elect these rich ***** who don’t give a ***** about you. They don’t give a ***** about you . . . they don’t give a ***** about you. They don’t care about you at all . . . at all . . . at all, and nobody seems to notice. Nobody seems to care. That’s what the owners count on. The fact that Americans will probably remain willfully ignorant of the big red, white and blue dick that’s being jammed up their ass everyday, because the owners of this country know the truth. It’s called the American Dream, ’cause you have to be asleep to believe it . . .”

  16. deadhead says:

    Not that Rosenberg needs a nobody like me to defend him, but I must point out the facts to those who insist he has made bad calls since the lows of March. I’ve read every Rosie piece since then and he repeatedly said that people should not be surprised to see the SPX go as high as 1200. Even though he believes the equity markets are overvalued, he issued that warning on several occasions.

    This is simply a fact.

  17. investorinpa says:

    Deadhead, that’s called hedging your bets…if you are in the business of being a market forecaster, your headline should be “SPX heading to 1200!” not “Doom and gloom abound, get ready for another crash!”. This is like saying you expect the Cardinals to win tonight, but wouldn’t be surprised one bit if Green Bay won.

    All guts, all glory. No guts, no glory. No glory for Rosie..he’s been wrong for a good while now. I don’t necessarily disagree at all with his premise, just that he has been wrong on the market.

  18. If anybody has captured the investment philosophies if this common man Barry, it is Bernstein

    Income, or cash flow as he puts it, is empowerment for the common man. It is the key to freedom and peace of mind

    @cognos Says: January 10th, 2010 at 1:14 pm

    The right thing to have is leverage to hard work and invention in your own business, OR leverage to your intelligence/training in the right field, OR leverage to smart investments after mild or serious downturns.

    The problem is that leverage, taken to the extreme (which is where I test all theories), is just someone else’s savings. Only the selfish few can thus benefit from that philosophy as we, and the next few generations are learning and will learn over the next decade or so. Fewer can win by leverage than by savings and investment

  19. km4 says:

    > How the Common Man Sees It Says: January 10th, 2010 at 8:30 pm
    If anybody has captured the investment philosophies if this common man Barry, it is Bernstein. Income, or cash flow as he puts it, is empowerment for the common man. It is the key to freedom and peace of mind.

    Bingo ….fucking…. bingo and why I operate as a solo consultant for ‘select’ software startups ;)

  20. bman says:

    investorinpa Says:

    January 10th, 2010 at 4:13 pm
    Cognos has it 100% right…

    Ahem, I’d say Cognos needs to get a job.
    To think you can just make money off your money needs to get taxed.
    50% of your interest or dividend earned should go to the IRS.

    You can take your silly risks, that way that way if you lose, well you’ve really ventured something.
    If you gain something, well you help everyone.

  21. cgb22 says:

    I think Rosie has misrespected what the market is seeing.

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  24. ToNYC says:

    to DL respectfully:
    when Investor #1 follows your plan and employs financial instrument “X” to execute his mission to thrive and reproduce, and the “X” = LEH, or E, that investor #1 is gonzo alonzo.
    And a hat tip to the greats Paul Tudor Jones and Jesse Livermore, “Losers average Losers, not Reproducers.”
    Ask the size locals, huge sellers of OTM S&P put options in October 1987…. if you can find them.

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