Is bull market moving into a dangerous phase?
It’s likely in the final stage — but when it ends is anybody’s guess
The bull market for stocks, which turns 9 on Friday, is getting up there in age and likely has entered its final phase.
Just as people have life stages, so do financial “bulls,” which are long periods of rising stock prices lasting about five years on average. If you invested in the current one, you’re happy: Putting $100,000 in a broad index fund at the start of the bull on March 9, 2009, and keeping it there would have boosted your investment to $425,000 today.
But know this: Each phase of a bull is distinctive, with unique rewards and risks for investors, whether they manage a 401(k) or day trade.
“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria,” said the late Sir John Templeton, the legendary value investor, laying out the four stages of a bull.
So what stage is our bull market in now? Using Templeton’s words as a guide, we have probably entered “euphoria,” but even this final phase can last a while, and no one knows when it could end.
Here’s the rundown of a bull market’s life cycle:
Stage 1: Pessimism
Bull markets start in a mood of doom after bruising stock market downturns, like the 57% drop sparked by the 2008 financial crisis and the bursting of the dot-com bubble in 2000 that wiped out half of the market’s value.
People who feel burned by the collapse are still in a pessimistic state of mind. But despite all the angst, the market stops going down on
“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria.”
Sir John Templeton Legendary value investor
bad news.
The so-called “smart money” sniffs out a market bottom and begins to get back in. And a stock rebound ensues.
Investors’ mind-sets shift from fear of more losses to a belief that an opportunity to make money has finally arrived, according to Woody Dorsey, a behavioral finance expert and president of Market Semiotics, a Castleton, Vt.based firm that provides market research to big institutional investors.
In this phase investors say, “‘Oh, OK, the market went too low,’” Dorsey explains. “We are having a nice recovery. That makes sense.”
Stage 2: Skepticism
In this phase, hesitation, suspicion and mistrust creeps back into investors’ thinking, even though the market has climbed well off its “bear” market low and economic indicators have turned up.
Investors wonder: Is the rally for real? Has the market bottom really come and gone?
Fears of a market relapse emerge.
Stage 3: Optimism
This is the stage where negativity gives way to rising optimism. A feeling of acceptance emerges, as people conclude that the market has stabilized and it is safe to start investing again.
Fears of a recession fade, unemployment plummets and economic growth returns.
Companies’ earnings improve, providing support for stocks. And more investors put money into the market.
As a result, the stock market becomes a less scary place. Wild swings start to fade, as happened in 2017 when the broad market never suffered a drop of 3% or more. Even when stock prices dip, investors use it as an opportunity to buy shares and then ride prices higher.
“Traditionally, this is the longest phase,” says Briank Belski, chief investment strategist at BMO Capital Markets. “It’s about a rebound in confidence and a rebound in the believability factor in the art of investing.”
Stage 4: Euphoria
This is when the love affair with stocks becomes a fatal attraction.
“It’s the opposite of a selling panic, it is a buying mania,” Dorsey explains. “Investors say, ‘OK, I am all in.’ Just like a gambler with three queens.”
“Irrational exuberance” emerges. Investors start to think nothing can go wrong and stocks will never go down again. Mom-and-pop investors come off the sidelines and start buying up stocks. Stocks rise at an unsustainable pace, ultimately setting the market up for a major fall.
That pretty much sums up the bull market’s final stage of euphoria.
“Of the four stages, the most important one is the last one: the irrational exuberance stage,” says Ed Yardeni, chief investment strategist at Yardeni Research.
Yardeni says the sharp rise in stock prices earlier in January, which followed last year’s 20% rally on optimism over tax cuts, signaled that the bull market has entered its final phase.
But, he stresses, this last stage “can last a while longer.”
But when it does end, stock prices are likely to fall far and enter a new bear market, or drop of at least 20%.
The selling begins when “new information forces people to readjust their views about the market,” explains Jean-Paul Rodrigue, a professor of global studies and geography at Hofstra University in New York who back in 2008 mapped the “main stages of a bubble.”