The Three Stages of Primary Bull Markets and Primary Bear 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.

Primary Bear Market - Stage 1 - Distribution

Just as accumulation is the hallmark of the first stage of a primary bull
market, distribution marks the beginning of a bear market. As the "smart
money" begins to realize that business conditions are not quite as good as
once thought, they start to sell stocks. The public is still involved in the
market at this stage and become willing buyers. There is little in the
headlines to indicate a bear market is at hand and general business
conditions remain good. However, stocks begin to lose a bit of their luster
and the decline begins to take hold.

While the market declines, there is little belief that a bear market has
started and most forecasters remain bullish. After a moderate decline, there
is a reaction rally (secondary move) that retraces a portion of the decline.
Hamilton noted that reaction rallies during bear markets were quite swift
and sharp. As with his analysis of secondary moves in general, Hamilton
noted that a large percentage of the losses would be recouped in a matter of
days or perhaps weeks. This quick and sudden movement would invigorate the
bulls to proclaim the bull market alive and well. However, the reaction high
of the secondary move would form and be lower than the previous high. After
making a lower high, a break below the previous low would confirm that this
was the second stage of a bear market.**

Primary Bear Market - Stage 2 - Big Move

As with the primary bull market, stage two of a primary bear market provides
the largest move. This is when the trend has been identified as down and
business conditions begin to deteriorate. Earnings estimates are reduced,
shortfalls occur, profit margins shrink and revenues fall. As business
conditions worsen, the sell-off continues.

Primary Bear Market - Stage 3 - Despair

At the top of a primary bull market, hope springs eternal and excess is the
order of the day. By the final stage of a bear market, all hope is lost and
stocks are frowned upon. Valuations are low, but the selling continues as
participants seek to sell no matter what. The news from corporate America is
bad, the economic outlook bleak and not a buyer is to be found. The market
will continue to decline until all the bad news is fully priced into stocks.
Once stocks fully reflect the worst possible outcome, the cycle begins
again.