The Three Stages of Primary Bull Markets
Hamilton identified three stages to both primary bull markets and primary bear markets. These stages relate as much to the psychological state of the market as to the movement of prices. A primary bull market is defined as a long sustained advance marked by improving business conditions that elicit increased speculation and demand for stocks. A primary bear market is defined as a long sustained decline marked by deteriorating business conditions and subsequent decrease in demand for stocks. In both primary bull markets and primary bear markets, there will be secondary movements that run counter to the major trend.
Primary Bull Market - Stage 1 - Accumulation
Hamilton noted that the first stage of a bull market was largely indistinguishable from the last reaction rally of a bear market. Pessimism, which was excessive at the end of the bear market, still reigns at the beginning of a bull market. It is a period when the public is out of stocks, the news from corporate America is bad and valuations are usually at historical lows. However, it is at this stage that the so-called "smart money" begins to accumulate stocks. This is the stage of the market when those with patience see value in owning stocks for the long haul. Stocks are cheap, but nobody seems to want them. This is the stage where Warren Buffet stated in the summer of 1974 that now was the time to buy stocks and become rich. Everyone else thought he was crazy.
In the first stage of a bull market, stocks begin to find a bottom and quietly firm up. When the market starts to rise, there is widespread disbelief that a bull market has begun. After the first leg peaks and starts to head back down, the bears come out proclaiming that the bear market is not over. It is at this stage that careful analysis is warranted to determine if the decline is a secondary movement (a correction of the first leg up). If it is a secondary move, then the low forms above the previous low, a quiet period will ensue as the market firms and then an advance will begin. When the previous peak is surpassed, the beginning of the second leg and a primary bull will be confirmed.
Primary Bull Market - Stage 2 - Big Move
The second stage of a primary bull market is usually the longest, and sees the largest advance in prices. It is a period marked by improving business conditions and increased valuations in stocks. Earnings begin to rise again and confidence starts to mend. This is considered the easiest stage to make money as participation is broad and the trend followers begin to participate.
Primary Bull Market - Stage 3 - Excess
The third stage of a primary bull market is marked by excessive speculation and the appearance of inflationary pressures. (Dow formed these theorems about 100 years ago, but this scenario is certainly familiar.) During the third and final stage, the public is fully involved in the market, valuations are excessive and confidence is extraordinarily high. This is the mirror image to the first stage of the bull market. A Wall Street axiom: When the taxi cab drivers begin to offer tips, the top cannot be far off.