Wild ride: if you've been riding the bull market you could be in for a tumble

Entrepreneur, Feb, 1997 by Lorayne Fiorillo

Even if you're not a member of the Sierra Club, the names of certain animals may linger on your lips: With the market so bullish now, can bears be far behind? Whether you classify yourself as bullish or bearish, one thing holds true: Knowing when to buy or sell is as important as knowing what to buy or sell.

For stock investors, the past two years have seemed like a fairy tale; even the ugliest duckling turned into a swan. As stock markets climbed to new highs, creating vast sums of wealth, investors barely noticed the passage to the next round number. Pundits urged them on with projections of the Dow Jones industrial average at 7,000 by 1997 or 10,000 before the end of the century. Others urged caution, citing the Newtonian theory of the stock market: What goes up sooner or later comes back down . . . even if only briefly. The question remains, which animal will end up on the endangered list - bulls or bears?

Predictions of stock performance and investment timing are based on a myriad of indicators, from the style of women's fashions (shorter hem-lines and higher heels are considered bullish) to the level of consumer debt (high debt is considered bearish). Making sense of the movement of stocks is tough enough, but to predict the market's next move, you may want to rely on your fairy godmother.

There are two general approaches to timing the purchase or sale of securities:

* Fundamental analysis uses information on economic growth and industry and company statistics to estimate the value of an individual security and the valuation of the market. Information is often gleaned from annual reports and studies of a company's earnings, dividend yield and its price compared to its earnings.

* Technical analysis relies on the assumption that stocks trade in definite and predictable patterns. The most popular type of technical analysis involves charting a stock price's movement and looking for trends that will enable you to predict future market movements.

If you're used to talking about bull and bear markets, you're already familiar with the charting aspect of technical analysis. The use of the terms bull and bear to signify different movements of the equity markets probably started with the advent of the Dow theory, one style of technical analysis named after Charles H. Dow, an editor of The Wall Street Journal during the early 1900s. Although originally designed to predict changes in business activity, the Dow theory has become popular as a way to forecast stock market activity.

* PRINCE OR PAUPER?

At its most basic level, a bull market is one in which most stock prices rise, while a bear market is when stock prices fall. Bull markets develop in four phases.

In Phase One, stock prices are low, and investors are exasperated with stocks because of their recent decline. Few investors are interested in stocks, and many are convinced stock prices may never rise again.

During Phase Two, stock prices start to rise and trading activity increases. Corporate earnings increase, and the economy looks healthy. People decide maybe stocks aren't such a bad investment after all, and they slowly return to stocks.

In Phase Three, both business and financial markets look great - in fact, everything's coming up bullish. The markets are reaching new highs, and everyone is talking about their portfolios. Your broker is your favorite person. You almost talk to him or her more often than you speak to your spouse. By this time, most stocks are at new highs and may be at the top of what they're worth. The dividend yield of the averages is low compared to historical levels because of overvalued stock prices, and Phase Four is right around the corner.

The final phase of a bull market is marked by speculation and frenzied buying of stocks that have no apparent value or earnings. Initial public offerings (IPOs) are the hot item of the day, the name of the latest company to go public is on everyone's lips, and stock prices have gone into orbit.

Often, bear markets are marked not by a single cataclysmic event (like a market crash), but by a gradual eroding in the fabric of the market. Like its fellow animal, the bear market is composed of four phases.

Phase One starts during the last two phases of the bull market, where investors who purchased low begin to sell their stock and take profits. Market rallies become less pronounced, and there is less potential for profit.

Some technicians call Phase Two of a bear market "the panic stage" because stock prices decline sharply. Investors sell shares to avoid even bigger losses as stock prices come back to earth. Unfortunately, the faster people sell, the faster and further stock prices fall, so they sell more - and on and on.

Phase Three sees some improvement in stock prices, as prices rise and investors recover from very oversold conditions. Phase Four often involves a long slide in stock prices as values drift ever lower until investors decide they are low enough and the buying (and the bull market) resumes.

* THE SKY IS FALLING!