Even though major U.S. indexes are pressing on new highs, the path to this point has been labored and hard. That will change.

The reason is that the stocks that paved the way were largely slow-moving value plays like Johnson & Johnson JNJ, -1.40% and Coca-Cola KO, -0.66% which have all the grace and agility of bulldozers. They have done their job, but now it's time for much cheaper growth stocks to zip past them and take markets to the next, much higher, levels.

As this happens, many investors will remain anchored in the value-oriented, dividend focused world of the past few years. This is likely to be a mistake, as they will be trampled.

Why growth now, when economic data is still lousy — with the May manufacturing data released Monday suggesting a contraction may be imminent?

Because it's this very fear over a weak economy that makes stocks cheap, and cheapness is its own reward.

If that doesn't make sense, let me back up a moment with help from Steve Reynolds, a portfolio manager and analyst at Craig Drill Capital in New York.

You see, one of the great unknowns on Wall Street, despite so many years of study and practice, is where price movements really come from. That might sound kind of ridiculous to say out loud, but the question of which current factors really predict stock performance in the future is still hotly debated.

The Vanguard Group, in fact, just published a report that declared, and don't fall off your chair when I say this, that the most important factor for predicting future performance over the past 86 years has been valuation.

Seems like a no-brainer, but apparently they felt obligated to prove the key factor is not national GDP trends, revenue growth, earnings growth, Treasury yields, dividends, price momentum or inflation. Just plain old price/earnings multiples. That is, if you pay little enough for a stock, it has the best chance of outperforming for you in the future. So their advice, no kidding, is to buy low and sell high.

I may sound a little sarcastic, but actually, the question gets a little more interesting when you take another step and start to think about where valuation comes from. And that is where a research piece published this week by Reynolds comes in handy.

Reynolds observed that valuation actually stems from all of those other elements. As economic and corporate fundamentals weaken, investor sentiment worsens, leading to falling stock prices and, thus, lower valuations. Conversely, as conditions improve, spirits are buoyed and markets advance. So the most effective way to manage money is to master the timing of the swings of psychology.

Emotions, in short, are the catalyst that morph economic events into stock-market moves. That is to say, when there is a little bad news, people freak out and sell stocks hard. And vice versa. Suffuse an environment with positive stimulus for long enough, and investors will push stocks a lot higher. Both these elements show up as lower or higher price/earnings multiples, or valuations. Bear-market P/Es for major companies tend to base around the 7 to 8 times level, while in bull cycles they tend to top out at 25 to 30.

Reynolds notes that the range of underlying economic outcomes are significantly less volatile than the extremes of investor psychology — and therein lies the opportunity for traders and investors.

Since behavioral finance analysts have proven that recent past personal experiences influence current investment sentiment, strategists should study investors' recent financial history in order to assess their future willingness to purchase equities. Reynolds proposes that a simple measurement of this risk tolerance might be this: ERP = P = (W+I)/N + delta (W+I).

In this formula, ERP is equity risk preference, P is investor psychology, WI is wealth and income and N is financial needs. The more positive investors feel about their current financial conditions, the more likely they are to purchase equities. Conversely, negative experiences lead to equity liquidation. It's nice to think the opposite would be true, but there are very few real contrarians.

Reynolds points out that in moving from recession and bear-market lows to recovery and bull-market highs, there is a natural tendency for investors to assume greater risk, reallocating portfolios from defensive securities to ones with more aggressive growth characteristics. In the United States, this process of moving from pessimism to optimism is currently underway, as depicted by the chart you can see here, which was created by Reynolds' firm.

At bear-market bottoms, psychology is at a nadir [(W+I)/N = 50%] and margin calls are at a peak. As the market improves, balance sheets are repaired, but not enough to mend confidence and stem equity liquidation. However, once investors have recouped their losses, Reynolds observes, negative sentiment has abated, the process of equity accumulation begins.

Reynolds argues that the U.S. stock market is now at this ideal inflection point. Looking forward, additional market gains will increase confidence and equity risk preferences will continue to rise. Then, as all good things must come to an end, the eventual self-reinforcing interplay between extreme euphoria and imprudent leverage will culminate in speculative excess.

The good news, in short, is that we appear to just be in the rehabilitation phase of the market psychology cycle and are embarking on a period of wealth creation — a virtuous cycle. As the market moves higher, it is crucial to understand how this improving sentiment will be expressed in stock selection.

At the market bottom in 2008-2009, the outlook for equities was dismal. The trailing 10-year market return was negative and psychology so pessimistic that even deep-value players despaired. Pension- and endowment-fund sponsors were demoralized over the prospect of low-single-digit returns. With annual actuarial assumption mandates of roughly 8%, they were operating in a crisis mode, Reynolds notes.

He explains that traumatized investors maintained historically high fixed-income and cash holdings. Risk aversion was the portfolio managers' mantra as the market rallied, however, a modicum of confidence was gradually regained, and gradually positions were increased in high-yielding stocks and low-quality bonds.

As performance lagged the market indices, Reynolds says, managers adopted the concept of "risk-adjusted returns" to rationalize their subpar absolute results. By early 2013, four years of gains had improved psychology, and they dared to look back and saw with some horror that they had driven the road to the current point too cautiously.

The U.S. stock market had delivered an annual total return in excess of 15%; well above previously dire expectations and, fortunately, well in excess of actuarial needs. And yet, most investors were too cautious to achieve that. While in 2009, the look back over your shoulder suggested overly conservative strategies, now the look back is signaling that it is time to speed up.

The best part of Reynolds' analysis is coming up. He notes that even though improved market psychology is on the cusp of enticing investors to take on greater risk, the economic outlook continues to be relatively uninspiring. Though the persistent headwinds that have been buffeting the economy are finally abating, the monetary and fiscal stimuli are simultaneously slowing.

These offsetting forces leave the United States with a subpar, slow-growth, flattish recovery; one likely to linger indefinitely, he says. For investors, this is troublesome, since the number of companies able to demonstrate strong, organic revenue and profit growth is rapidly declining.

At the start of the economic recovery, the majority of companies showed a significant rebound in earnings from depressed recession levels. The analyst observes that this leaves investors in a dilemma: Investors now have a rising propensity to increase equity exposure and a declining universe of attractive investment alternatives. He calls this the "Reynolds Paradox," and it is a very clever concept.

The preponderance of portfolios today are conservatively structured, both in equity exposure and stock selection. If they remain invested in high-yielding, slow- and no-growth companies, like most consumer staples, they will find themselves caught in "value traps." Frustration from underperformance will compel managers to move into a faster lane, he observes.

As a result, Reynolds argues that the transition from the current value/yield leadership to growth stocks is just around the bend. From bond-substitute, income-oriented equities, investors will, with caution, embrace growth at a reasonable price. They will seek investments with predictable growth prospects and conservative valuations, he suggests.

But it doesn't stop here. As the bull market grinds forward, the improved absolute returns will lead to a marked rise in confidence. Reynolds observes that avarice will begin to replace caution, spawning more creative and riskier investment policies. Increasingly, momentum strategies will be embraced and sharp pencils, rulers and chart books will replace sophisticated mathematical models.

Eventually, the rear-view mirror will only reflect a limited number of exemplary companies capable of "perpetual" growth. Pundits will re-coin the term "one-decision stocks," ones to be bought and never sold. Almost cult-like, Reynolds argues, investors will continue to crowd into this narrow list of global growth names whose valuations will become egregious. A new, global "Nifty 250" will be born.

Beware: Great bull markets frustrate the most sober-sided and seemingly rational participants. Value, income and disciplined growth investors will be left in the dust, seeing only the fading tail lights of the reckless, irrationally exuberant momentum managers.

At the peak of the sentiment cycle in years to come, confidence will be so elevated by bulging wallets and inflated egos, Reynolds concludes, that investors, traveling at high speeds, trusting only their rear-view mirrors, will recklessly ride off the road.

But don't worry too much about what will happen far down the road. The joy ride has barely begun, and has many miles to go before it is done.

My recommendation: Be prepared to buy growth stocks and ETFs on 2% to 10% dips now — techs, like Select Sector SPDR-Technology XLK, -1.71% , financials like Select Sector SPDR-Financial XLF, -1.48% , and industrials like the XLI, -0.27% — and don't remain anchored in the value-oriented, consumer staples, dividend-focused world of the past few years.

In short, it may not look like a time to bet on an improved economy, but really that is the best time to do so.

Disclosure: Markman owns the XLF.