This Wall Street legend has lived through every bear market since the 1950s. He says the next one could hit the S&P 500 with a 30% loss.

Farrell’s iconic 10 “Market Rules to Remember,” published in the late 1990s when he was a senior investment adviser at Merrill, should be required reading for financial industry professionals and individual investors alike.

This market survival manifesto, whose dispassionate reality is a welcome antidote to Wall Street’s typically sunny salesmanship, is particularly pertinent now, as investors are daily reminded that stock prices are neither immune to of gravity or the fists of the Federal Reserve.

Farrell stays out of the public eye today, but he recently shared his forecast for US equities in an interview with David Rosenberg, a respected veteran market strategist. Rosenberg, a former chief economist at Merrill and now a director of his own firm, Toronto-based Rosenberg Research, frequently refers to Farrell’s sobering rules in research papers deciphering market movements for institutional clients. These rules, says Rosenberg, are his “10 investment commandments.”

In the April 27 webcast for Rosenberg Research clients, Farrell said he expects investors in US stock indices could be hit with a 30% loss and that downward pressure on stock prices the actions could last until the summer. He advises selling rallies rather than buying dips, and otherwise taking refuge in value stocks, specifically in the defense, cybersecurity, utilities and energy sectors, as well as owning GC00 gold.
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and income-generating master limited partnerships.

“We are in a bear market,” Farrell said. (Rule #8: “Bear markets have three stages: sharp decline, reflexive bounce, and a prolonged fundamental downtrend.”) “Growth technology is losing popularity; we are gradually breaking down the large-cap stocks that have held the S&P 500 SPX,
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up. By the time this is over, everyone is likely to enter further decline. If the S&P 500 goes down 30%, which I think is a possibility, then you would be at 3460.”

At the close on May 9, the S&P 500 was down nearly 17% from its all-time closing high of 4,796.56 reached on January 3.

For Farrell, the current market crash is a natural outgrowth of the exuberant bull run that was fueled by easy money and excessive speculation. Especially in the last two years, the fear of missing out has lured many new and inexperienced buyers to stocks, lulled by the naive confidence that what goes up keeps going up.

“The longer a trend persists, the more people see it as permanent,” Farrell said. (Rule #3: “There are no new eras: excesses are never permanent.”) “That’s why investors buy most of an asset, like stocks or bonds, at high prices and less at lows.” (Rule No. 5: “The public buys more at the top and less at the bottom.”)

Now the pendulum is swinging backwards. Where it stops, no one knows, of course, but you can trust Farrell’s rule number 2, which states: “Excesses in one direction will lead to an opposite excess in the other direction.”

As Farrell explained in the interview: “Speculative periods are followed by a meltdown because they usually go too far or don’t pay enough attention to the fundamentals.” (Rule #4: “Exponential markets that go up or down quickly usually go further than you think, but don’t correct by going sideways.”)

Speculation in the stock market is falling apart now, but the S&P 500 SPX,
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for example, it is still highly concentrated, with around 25% of its performance linked to the performance of five popular stocks, mostly from the technology sector.

Farrell said: “Concentrated ownership is a cyclical measure of vulnerability or future potential, depending on how concentrated or how little a sector or group is owned.” Put another way, the US stock market has been something of an inverted pyramid, a flimsy foundation that investors can and do ignore until the pyramid collapses.

“Similar concentrations occurred in 1970-72, when the ‘Nifty Fifty’ were dominant. And in 1998-2000, when big tech was dominating,” Farrell said. “In each of these cases, there were 10-year low cycles [after the collapse] in concentrated leaders.”

Biggest, best-loved stocks fall hardest underscores Farrell’s Rule No. 7, which states: “Markets are strongest when they are broad and weakest when they are reduced to a handful of blue-chip names.” He also references Rule No. 9: “When all the experts and forecasts agree, something else is going to happen.”

From the MarketWatch archives: 10 investment rules tailor-made for tough markets

For the bulls to regain control, Farrell said he would watch for evidence of capitulation on the part of investors: selling pressure and days of big drops, in other words, setting up a lasting advance. (Rule #6: “Fear and greed are stronger than long-term resolve.”) Going forward, Farrell expects value stocks, gold, utilities and energy to emerge as the new market leaders, at least in the short term, and for the major US stock indices in general to provide below-average returns. (Rule No. 1: “Markets tend to revert to mean over time.”)

Many index fund holders will be disappointed if this happens, of course, which is why Farrell encourages investors to add more active management to their portfolio. Said Farrell: “We are moving from a period of making the best money in an index fund to a period of making money by identifying the right individual stocks and sectors. I would focus more on that.” (Rule #10: “Bull markets are more fun than bear markets.”)

Plus: Prepare for a recession, a bear market in real estate and a drop in stock prices, warns strategist David Rosenberg

Also: ‘The Fed Always Screws Up’: This Forecaster Expects Inflation To Peak And US Stocks To Be In A Bear Market By Summer