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Phases of a Bull Market

Phases of a Bull Market

One of the most important steps in deciding where markets may go is establishing "where are we right now?". With US share markets hitting new all time highs again overnight, it's a good time to take a step back and take a big picture view of the US market:

US SP500 Index - monthly

chart of the US sharemarketFirst, let's state the obvious - there is a clear up trend in place, starting in March 2009. Looking at the chart, this appears indisputable. I mention it because I regularly come across "perma-bears" in dark corners of the interwebs whose predictions of impending doom make no mention of the fact that they have been declaring looming disaster for most of the period that the US market has rallied by more than 180%. Markets may fall significantly, but those who've been predicting it through four years of one of the strongest rallies of all time will get no credit from me.

Many years ago, notable contrarian investor Sir John Templeton succinctly described the phases of a bull market in terms of investor sentiment:

"Bull markets are born on pessimism, grown on scepticism, mature on optimism and die on euphoria".

In March 2009, extreme pessimism moved towards despair. Bulls were harder to find than humble graduates, and commentary on market prospects veered into "never again" territory. With hindsight, this universal pessimism meant everyone who wanted to sell had done so, leaving only one direction for the market - up.

Scepticism accompanied the first two and a half years of the rally. Significant pull backs on the way supported the sceptics, although none of them became full blown routs. As the market continued to rise, cautious optimism emerged as the stimulus efforts of central banks lifted economic activity and asset prices. While risk and doubts remain, it is reasonable to propose that this is where the market sits - somewhere into the third phase of a bull market.

How will we know when we are entering euphoria? There are a number of signs that give the game away. On the charts, exponential  price action (prices rising at ever accelerating rates, making the charts look as if they are about to "go vertical") is usually a clear sign of the "blow off" phase. Mass participation is another - look out for share tips from taxi drivers. Wildly optimistic forecasts are also a part of this phase. A very successful former trading colleague looks for the newest variation on the phrase "it's different this time" as a sure sign the bull market is on its last legs.

At this stage there are no signs of euphoria. The trend remains clearly up, meaning for most trading plans the market should be played from the long side, as difficult as this may be after a four year, 180% plus rally.

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