Three Stages of a Bull Market
Identify who believes the recovery before choosing how much risk to take
- Difficulty
- Moderate
- Time to result
- ~weeks to results
- Steps
- 4
- Confidence
- 98%
The framework divides a bull market into three psychological stages. In the first, only a small group believes conditions can improve, so pessimism may leave assets attractively priced. In the second, improvement becomes broadly accepted and prices reflect much of the recovery. In the third, investors extrapolate progress indefinitely, compelling stories proliferate, and valuations can become dangerous. The investor first identifies the dominant belief regime, then checks whether prices and risk appetite confirm it. The output is not a forecast of when the cycle will turn; it is a decision about how aggressively to invest. As optimism becomes more universal and valuations rise, the framework calls for progressively greater caution.
Origin
Marks says someone shared the three stages with him in the early 1970s. He later incorporated the model into Mastering the Market Cycle and his investment thinking at Oaktree Capital.
Core principles
- 01Markets move through recurring psychological stages
- 02Early optimism can create bargains
- 03Broad acceptance reduces easy upside
- 04Universal optimism often produces overpricing
- 05Cycle position changes the odds, not the exact timing
How to run it
- 1
Identify the prevailing belief
Determine whether only a few investors expect improvement, most accept it, or nearly everyone assumes it will continue indefinitely.
Pro tip Focus on what investors collectively believe rather than on recent returns alone.
Watch out Strong recent performance does not reveal when the cycle will end.
- 2
Check valuation evidence
Compare prices, yields, spreads, and other relevant valuation measures with their historical ranges.
Pro tip Look for confirmation that optimism has already been incorporated into price.
Watch out A great asset can still be dangerous when purchased at an excessive valuation.
- 3
Test for extrapolation
Listen for arguments that prosperity will continue forever or that historical valuation rules no longer apply.
Pro tip Treat widespread use of exceptional narratives as evidence of elevated expectations.
Watch out Do not assume that a late-stage market must reverse immediately.
- 4
Adjust portfolio posture
Take more risk when pessimism creates bargains and become more defensive as optimism and prices become elevated.
Pro tip Change security quality, valuation, and duration before considering an all-cash exit.
Watch out The model improves odds but cannot provide exact entry and exit dates.
In the wild
After the 2008–09 collapse, few investors believed recovery was possible, creating an early-stage opportunity. Years later, the S&P 500 had quadrupled, valuations exceeded historical norms, and more investors accepted that the advance could continue. Marks concluded that the easy money had been made and that portfolios should take some risk off without assuming the bull market would end the next day.
→ The framework translated a mature recovery into a more defensive portfolio posture.
A portfolio manager notices that initially dismissed technology shares have become universally praised and trade far above historical valuation levels. Rather than forecast an immediate crash, she shifts from speculative names to profitable companies purchased at less demanding prices.
→ The portfolio remains invested while reducing exposure to late-cycle optimism.
Common mistakes
Treating stages as a clock
The stages indicate psychological and valuation conditions, not how many months remain before a reversal.
Waiting for unanimous euphoria
A market can become expensive and risky before literally every investor is optimistic.
Exiting solely because the cycle is mature
Elevated conditions can justify caution without making cash preferable to every investment.
Is it for you?
Best for
It is best for investors deciding whether current market conditions justify aggressive, neutral, or defensive positioning.
Not ideal for
It is not ideal for precise market timing or predicting the date of a correction.
From the transcript
“The first stage, when only a few incredibly insightful people believe there could be improvement, the second stage, when most people accept that improvement is…”
“In investing, we sometimes know what's going to happen, but we never know when.”
“If we're low in the cycle, we should be aggressive. If we're high in the cycle, we should be defensive.”
From the episode
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