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The Third of Death

Bull markets are, of course, trickier to segment neatly than bullfights. Models that assume faithfully repetitive price behaviour, such as the Elliott Wave Principle's sequence of three moves up and two down, are the least useful. According to most prominent Elliotticians, the bull market in the US and UK equities is on its last legs, as indeed it has been for the past four years.

Mood and the market

Models that describe the shifting mood among investors, but without being overly prescriptive about price action, offer a better approach. The attached chart from Fisher Investments UK, a firm that rightly and almost uniquely foresaw last year's bumper gains on Wall Street, is a great example of this. Fisher believes that investors have yet to develop the sort of rampant optimism that is typically seen at market tops.

Dow Theory - a branch of analysis for which I have a lot of time - splits bull markets into three stages, just like a corrida. The first stage is called "accumulation", where savvy investors acquire equities amid widespread pessimism. This corresponds initially to a loss of momentum in the downtrend, and then a sharp rally. I see accumulation as having begun in late 2008, with sharp gains from March 2009.

S&P Accumulation

Once the uptrend is established, "public participation" begins. The first move upwards in a bull market is typically treated with suspicion by trendfollowers, and rightly so. We demand confirmation that the move is the real McCoy, rather than just yet another suckers' rally within a downtrend. Dating the start and the end of public participation is trickier. I would say it probably began around late 2009 and went on until the end of 2012.

The Dow Theory's "third of death" is called distribution. It is characterised by rampant speculation and savvy folk who bought in early on quietly "distributing" their holdings to less informed latecomers to the party. The last confirmed episode of distribution was in 2006-07, when Joe Public began furiously buying property funds and natural resources shares.

Nasdaq distribution

Distribution in the current bull market likely began at the start of 2013 and remains ongoing up to the present. The galloping gains in eye-watering expensive internet and biotechnology stocks last year is as plain asymptom of rampant speculation as I could think of. Meanwhile, those in the know are dumping stock. According to Professor Nejat Seyhun of the University of Michigan, the message of recent net insider selling is at its most bearish in a quarter of a century.

I remain firmly of the view that the estocada - or fatal sword-blow for today's bull-run - is the forthcoming end of US quantitative easing. In very rare circumstances, an exceptionally brave bull can be reprieved by the bullring's president, who waves an orange handkerchief. The Federal Reserve has twice already been forced to spare the bull market's life by restoring QE, and will almost inevitably have to do so again. The question for me is quite how much suffering equities will have to go through beforehand. Reprieved bulls have sometimes expired on the way back to the ranch.