The Seven Rules Of Wall Street

The Seven Rules of Wall Street Crash-Tested Investment Strategies that Beat the Market AUTHOR: Sam Stovall PUBLISHER: McGraw-Hill Books DATE OF PUBLICATION: 2009 192 pages

THE BIG IDEA

In The Seven Rules of Wall Street , Sam Stovall, master investment strategist and expert on stock market history, presents seven familiar sayings that:

convey enduring truths

serve as superb investment strategies

WHY YOU NEED THIS BOOK This fun and lively book provides an abundance of wisdom in remarkably few words . It proves that investing books can be as entertaining as they are educating.

Rule 1 – Let Your Winners Ride, But Cut Your Losers Short Always remember that history is a great guide, but it is never gospel. No investment technique works all of the time. The Let Your Winners Ride, but Cut Your Losers Short rule underperformed the broader market three years in a row , from 1987 to 1989. Yet it beat the market 10 years straight from 1971 to 1980, including the mega-meltdown years of 1973 and 1974.

Rule 1 – Let Your Winners Ride, But Cut Your Losers Short

In the end, an investor who doesn’t stick with a particular discipline, and frequently changes allegiances, will likely give up on following rules altogether.

So:

either embrace a single rule that you favor most and stick with it

or embrace two rules, directing half of your money toward one rule and the other half toward the second rule

Rule 2 – As Goes January, So Goes the Year Developing a January Barometer portfolio for either sectors or industries is amazingly simple – Just select the three S&P 500 sectors, or 10 industries, that posted the best performances during January and hold them for a year. That’s all you have to do.

Rule 2 – As Goes January, So Goes the Year You may be surprised to discover the magnitude and frequency of rewards you could have reaped by taking a cue from a single month’s performance. You may also be surprised to find out that the January Barometer portfolios frequently beat the market whether the S&P rose or fell in January.

The market and most sectors typically take a “price-appreciation vacation” during the summer months. In 2008, while the S&P 500 fell by more than 30% from May through October, the S&P Consumer Staples and Health Care sectors fell by about half that amount . They improved not only on their frequency of beating the S&P 500, but also the margin by which their average compound return beat the market . Be reminded that there is also no guarantee that what worked in the past will continue to work in the future. Rule 3 – Sell in May and Then Go Away

Rule 4 – There’s No Free Lunch on Wall Street (Oh Yeah, Who Says?) If you could get something for nothing, it wouldn’t take long before many others joined you in this investment . And as more people would learn about it and buy into it, the potential to exploit any price inefficiency would evaporate . It’s the simple principal of arbitrage.

Rule 4 – There’s No Free Lunch on Wall Street (Oh Yeah, Who Says?) Sometimes, however, one can find an investment strategy that delivers a free lunch: An investment that offers an improved return with lower risk. Investing in sectors with low correlations to one another has actually provided investors with above-average returns – even when factoring in risk or volatility.

What this rule endorses is that instead of

picking sectors, industries, or stocks by trying to forecast where we are in the economic cycle

projecting which company will win a government contract

or guessing which way the dollar will fluctuate

let the market tell you where to invest your money.

With Rule 5, There’s Always a Bull Market Someplace, you can let the market tell you which areas to buy into and when to sell out.

Rule 5 – There’s Always a Bull Market Someplace

Rule 6 – Don’t Get Mad – Get Even!

What should an investor take away from this rule?

First, if you are a buy-and-hold investor who is looking to

neutralize the influence of cap size in your portfolio

and take advantage of the historical outperformance of smaller-cap stocks over larger-cap ones

Then you should invest in the equally weighted S&P 500 ETF.

Second, you might want to rotate between the equally weighted and market-cap-weighted S&P 500 indexes.

Rule 6 – Don’t Get Mad – Get Even!

Third is the extra octane an investor receives when substituting equally weighted sectors for market-cap-weighted sectors in the portfolios.

The Summary, Ranking the Rules , summarizes the performances, volatility, and frequencies of outperformance for each of the Seven Rules of Wall Street, using market-cap-weighted and equally weighted sector indexes.

How you implement the rule Don’t Get Mad – Get Even is just as simple as the ways you implement the other rules.

The mandate of the Federal Reserve is twofold:

to promote economic growth

to keep inflation under control

In other words, make capital (money) abundant enough so that consumers and companies will be willing to borrow money in order to expand and improve their overall quality of life.

But at the same time, be vigilant about the potential increase in inflation , as a result of too many people and companies chasing after a more limited supply of goods or services.

Rule 7 – Don’t Fight the Fed

Think of it this way. If the economy were a car, the Fed’s responsibility as a driver would be to maintain a safe speed . If the Fed wanted to speed things up, then they would step down on the gas by lowering interest rates . To slow things down , however, the Fed would need to tap or even slam on the brakes by raising interest rates and reducing the availability of capital. Rule 7 – Don’t Fight the Fed

The biggest challenge for the Fed is that our economy isn’t a little red sports car that reacts nimbly to the application of the gas pedal or the brakes. Instead, the economy is more like a supertanker whose response time is remarkably slow. It usually takes between six and 12 months for the economy to feel the stimulation effects of lower rates. It also takes quite some time for the economy to slow down as a result of higher rates. Rule 7 – Don’t Fight the Fed

And the Winner Is… Of all the portfolios, the one favored the most is There’s Always a Bull Market Someplace , which uses equally weighted S&P 500 sectors. It has all of the right statistics . And it offers an average frequency of annual outperformance that exceeds 70%. Even more encouraging is that this portfolio allows an investor to evaluate and adjust his or her portfolio every month.

And the Winner Is… As with all things in life, everyone has a different approach to investing. A discipline that sounds appropriate to one person may appear illogical to another. Therefore, you are free to select the rule that feels best to you. Good luck!

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