10 Rules of Investing: Investors Should be Proceeding with Caution

When Elon Musk was just 10 years old, teenagers Brian Wheat and Frank Bannon decided to start up a band in their hometown, Sacramento.

The name of the band — Tesla.

In 1990, Tesla did a cover version of the Five Man Electrical Band’s 1970 hit ‘Signs’.

Tesla changed the chorus line. Replacing ‘blockin’’ with…

Signs signs
Everywhere there’s signs
F***ing up the scenery
Breaking my mind
Do this, don’t do that
Can’t you read the sign

The song was written out of frustration from being constantly told ‘do this, don’t do that, can’t you read the sign?’.

Elon Musk has made a fortune from ignoring the signs. When it comes to the promotion of Tesla and his other enterprises, Musk makes up his own rules. And it occasionally lands him in hot water.

US Securities and Exchange Commission (SEC) September 2018:

Elon Musk Settles SEC Fraud Charges; Tesla Charged with and Resolves Securities Law Charge

Musk’s maverick style has obviously rubbed off on his shareholders. Rules of valuation? That’s sooooo old school.

Compare the pair or, the two Ts — Toyota and Tesla:

Port Phillip Publishing

Source: Yahoo! Finance

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Toyota trades on a P/E ratio (based on trailing 12-month) earnings of a very modest eight times.

Tesla, with hardly any earnings, has a P/E ratio in territory that only SpaceX could reach — 810 times.

To illustrate just how BIG this discrepancy is, here’s what each company earns:

Port Phillip Publishing

Toyota makes US$23 billion, that’s 46x more in earnings than Tesla. Yet, Toyota is less than half the value of Tesla. Go figure.

How is it that possible?

There’s only one reason…you blatantly disregard those old-school signs.

Ignorance of the rules can work for a while, but not indefinitely.

In 1957, Bob Farrell commenced his (stellar) career with Merrill Lynch.

For anyone interested in Farrell’s background, this is the link to his Hall of Fame page with the Institutional Investor.

Three Deep Value Stocks Currently Under-Priced: These ASX gems could potentially deliver market-beating returns as the economy recovers. Click here to learn more.

10 Rules of Investing

The decades Bob Farrell spent in good and bad markets provided him with the experience needed to develop his timeless (and often quoted) 10 Rules of Investing.

Farrell’s Rules provide an invaluable guide to investors who are looking for signs of when to be over and underweight shares.

1. Markets tend to return to the mean over time:

Reversion to the mean is a time-honoured mathematical principle. Markets can — for periods of time — deviate from the mean. But, eventually, markets will recoil back from an under or overvalued position.

Based on the Shiller PE 10 ratio, you would have to expect at some time we will see the market adhere to Rule 1.

Port Phillip Publishing

Source: Guru Focus

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

This is a true for life as it is for markets. Too much of a good or bad thing eventually has consequences. The Shiller PE 10 chart shows how periods of extended under and overvaluation are followed by an equal and opposite force in the other direction.

3. There are no new eras — excesses are never permanent:

This time is different. New paradigm. New era. Going back to Tulip Mania, these same old clichés are trotted out time and time again to explain away the madness of men. It is never different. Why? Because of human nature. Greed and gullibility make people want to believe the rules no longer apply. Sadly, the rules do apply. Every single time.

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

Famed economist Irving Fisher said in September 1929 ‘stock prices have reached what looks like a permanently high plateau.

During the 1920s, the Dow had experienced an exponential rise in value. It was never going to plateau.

What do you think is in store for the modern-day Dow?

Port Phillip Publishing

Source: Macro Trends

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

During my years in the financial planning industry, the busiest periods always preceded market tops…1986/87, 1999 and 2007. Investors are drawn into hot markets like moths to a flame. Buying high and selling low is NOT the way to create long-term wealth.

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

Tesla’s PE of 810 times is nothing more than a reflection of investor greed. The desire to turn a dollar into a much greater sum in a short space of time is the only rationale behind that multiple. And when this market begins ‘reverting to the mean’, watch the fear take hold and drive Tesla PE ratio well into the double-digit range.

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

When an index is being pushed up by a broad spread of stocks being bought, it’s a positive sign the market is on solid footings. However, when you see headlines like this one from Forbes on 26 September 2020, that’s a sign of a very weak market:

Port Phillip Publishing

Source: Forbes

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

Here’s a chart of recent market action on the Dow…have we seen two of the three stages? And if we have, are we poised for a drawn-out fundamental downtrend?

Port Phillip Publishing

Source: Macro Trends

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

When everyone is thinking the same, then no one is thinking. The industry is always saying there is no bad time for a good investment. Well, I beg to differ. If you invested in late September 1929, it took you 25 years to make your dollar whole again. When every is predicting markets to continue going up or down, that’s when you have to start applying a little bit of lateral thinking of your own.

10. Bull markets are more fun than bear markets:

Ain’t that true. Making money sure beats the heck out of losing it.

My reading of the signs tells me that investors should be proceeding with the utmost caution.


Vern Gowdie Signature

Vern Gowdie,
Editor, The Rum Rebellion

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion