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The Four Phases Of Financial Markets

A framework for analyzing market moods

(Not intended to be investment advice. Opinions are my own.)

I have a simple way of classifying stock market conditions. Before I attempt to describe it in words, here’s a picture:

The four phases

So basically the market has four possible phases:

1. Valuations are expensive and market moves are driven by stories and narratives. Right now is a good example of this where the overarching narrative driving the surge in stock prices is “the rise of AI”. During times like this, a company’s proximity to the hyped narrative matters much more to its stock performance than its actual cashflows.
2. Valuations are cheap and market moves are driven by stories and narratives. Stories aren’t always good and bullish. Negative stories can dominate too, causing stocks (and other risky assets) to be unreasonably cheap. The 1970s was a good example of this where fears of stagflation crushed the valuations of even well-performing and highly profitable companies. This was a time when numerous quality companies could be bought at single digit PE (price to earnings) ratios.