The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage. The opinions expressed are those of the author and do not represent the views of TheStreet or its management.
NEW YORK (
) -- There is a phenomenon that takes place during every single bull market cycle. It's firmly rooted in human psychology and behavior. It involves levels of comfort, confidence and elation. It almost always follows the same pattern and invariably ends the same way.
The phenomenon I speak of involves bull market rallies and their tendency to shift through four different phases:
Phase 1 (the beginning of the bull rally)
-- Market participants are still licking their past wounds and are content to keep doing so. Most have made a vow to stick to bonds or real estate, swearing off stocks. Institutions allocate to equities very lightly. Wall Street as a whole is bearish and recommends the rest of the population be bearish as well.
trots out one bear after another, as if you were watching the Russian Circus Network.
Phase 2 (early recognition of a bull market)
-- Market participants begin reading more about the markets and following developments more closely. Some even log into their accounts after months of turning a blind eye to their brokerage statements. Institutions begin increasing their allocation to equities, but stick with more conservative names. Wall Street is mostly bearish, although some are beginning to think the worst may be behind us.
trots out the bears, with an occasional bull in between. The bullish pundits are only brave enough to recommend stocks such as
Johnson and Johnson
Procter & Gamble
Phase 3 (recognition of the bull market and a belief in it)
-- Market participants begin nibbling on stocks again. They are focused mainly on better known, more conservative names. Institutions ramp up the buying and are moving into more speculative names, mostly in technology. Wall Street comes alive with bullishness. Words or phrases like "optimistic, "cool," "great concept,", "fantastic," and "I love" are being used more often.
trots out a majority of bulls, with few bears. The bullish pundits begin shaking their tail feathers, and going out on a limb with ideas that involve technology. Concepts like "cloud computing" or "web 2.0 begin becoming catch phrases among the bullish guests.
Phase 4 (utter, complete and total confidence in the bull market)
-- Market participants begin pushing all-in. They become very aggressive and move into high-beta technology names. These are names that they buy at Phase 4 of bull markets every single time. Institutions begin joining in and allocating their money into more and more aggressive names at the behest of upper-management who don't want to fall behind the performance curve. Market participants have no tolerance for bearish opinions. Bullishness is widespread. Words or phrases like "secular bull market," "generational low," "booyah," and "massive" dominate the vocabulary of market participants.
trots out bull after bull. They begin recommending small to mid-cap technology stocks, while smiling excessively and joking with the anchors. A love-fest ensues between all, with the exception of Mark Haines, who remains grumpy.
There are certain names that the Phase 4 bulls will gravitate to every single time. The Phase 4 bulls love technology. The Phase 4 bulls also love memories of their previous victories within the technology sector, mainly before 2000. They can't help but move right back into the names that remind them of their youth. Similar to the guy who is obsessed with the idea of finding his high school or college sweetheart so that he can relive the glory days. Only problem is that girl he remembers as being 5-foot, six inches tall and weighing 125 pounds, now has three kids, has shrunk an inch and put on 50 pounds. Going after fantasies of the past often ends up in disappointment. The markets are no different.
The move I have seen take place recently in the optic and telecom names is very Phase 4-esque. The force and volume with which these names are moving up suggests a type of bullish euphoria taking place and a real lack of concern among the bulls. These are names that can wipe the enamel right off investor's teeth if they get in at the wrong time. Yet here we are, looking at names like
blow through the roof.
It's not just the fact that they are going up; it's the manner with which they are going up that should of the greatest concern. Phase 4 stocks tend to attract Phase 4 investors, meaning sloppy, run-with-the-herd type investors who simply pile in. The price action and volume seems to be confirming that Phase 4 investors are moving into Phase 4 stocks and throwing everything they have behind them.
Get cautious, get some cash and get ready. Phase 4 bulls are going to be having a change of vocabulary in the coming months, and the path to get there is never pretty.
Ali Meshkati is founder of Zenpenny.com, a Web site focused on investing in restructurings and special situations in micro-caps and penny stocks. Prior to Zenpenny, he managed Trillian Capital Partners LP, a top-ranked macro hedge fund. He has been trading the financial markets since 1994, working as an adviser to both individual clients, as well as an institutional trader with Bank of America.