Ever Heard Of A ‘Melt-Up’? The Market Is Headed For One!

FOMO or the fear of missing out is something you see in millennials, but so far this year, it is affecting investors and the market in ways I can not adequately explain.

Like others in the space, I am asking myself how can this market continue to run-up without any kind of correction.

Bull markets cannot last forever and we are standing in the middle of the second-longest on record.

So you and I stand there, wondering how and why and whether we should be actively putting new money into the market.

Here is my take on this… you should be wary and there is a good chance that maybe you should be putting more money into the market.

It’s a catch-22 and we have seen this movie before.

Everyone out there has their own unique situation, so act accordingly.  This could all end in a single trading session.

We are now entering a ‘melt-up’ phase in the markets.

What exactly is a melt-up?  Think about it for a second.

Investopedia defines the term melt-up as:

“A dramatic and unexpected improvement in the investment performance of an asset class driven partly by a stampede of investors who don’t want to miss out on its rise rather than by fundamental improvements in the economy. Gains created by a melt-up are considered an unreliable indication of the direction the market is ultimately headed, and melt ups often precede melt-downs.”

And this is just the beginning.  Once the MSM catches onto a word, they will use it over and over again.

Had anyone ever heard of a polar vortex before last winter when it was used ad nauseam?

We are most likely entering the late stage of a great bull market.

We have recently seen the Dow Jones Industrial Average cross 25,000, only to see it surge another 700-plus points since then.

And as you read this, the S&P 500 has already advanced by 3% since the start of the new year.

But this melt-up may be just getting started. (Economists and students of the market also sometimes refer to this as the “euphoria” stage.)

This shouldn’t scare you. In fact, some of the best gains to be had during bull markets are found during this stage. One need only think back to the tech bubble to remember this — some of the largest gains were made in the last year before it was all over.

A Value Investing Legend (And Assett Bubble Expert) Weighs In
Legendary value investor Jeremy Grantham, co-founder of GMO Capital, summed up the situation nicely in a letter to investors on January 3:

“I find myself in an interesting position for an investor from the value school. I recognize on one hand that this is one of the highest-priced markets in U.S. history. On the other hand, as a historian of the great equity bubbles, I also recognize that we are currently showing signs of entering the blow-off or melt-up phase of this very long bull market. The data on the high price of the market is clean and factual. We can be as certain as we ever get in stock market analysis that the current price is exceptionally high.”

He continued by pointing out that Ben Graham, the father of value investing, noted that no bubble can break without “signs of real excess.” He also noted Nobel Prize-winning economist Robert Shiller’s perspective that “not nearly enough signs of euphoria were yet present to make this look like a late-stage bubble.” (Shiller’s perspective, as he points out, is important here. He was one of only a handful who predicted the market’s collapse in 1999 and in 2006.)

Based on this, along with a statistical study of previous U.S. equity bubbles, Grantham extrapolated exactly what it would take to make it look like the S&P 500 was in a late-stage bubble.

“A range of 9 to 18 months from today and a price rise to around 3,400 to 3,700 on the S&P 500 would show the same 60% gain over 21 months as the least of the other classic bubble events.”

If this is indeed close to the truth, then it suggests we may have a lot more gains ahead of us. That should be encouraging. And while Grantham further says that while no two bubbles are the same, there does tend to be a concentration in the outperformance of “quality” stocks in a rapidly-rising market at the end of these cycles.

Part of the reason, he says, is it doesn’t particularly pay to bet against the market in these situations. So you’re kind of forced to “dance” to the tune of it — and you do it by betting on quality.

Look For These Anecdotal Warnings Signs
Finally, Grantham gives a few other tips on how to know whether we’re truly at the end of a bubble in the market…

“Anyone around in 1999 and early 2000 has had a classic primer in these signs. We know we’re not there yet, but we can perhaps see some early movement: increasing vindictiveness to the bears for costing investors money; the crazy Bitcoins of the world … and Amazon and the other handful of current heroes — here and globally — taking over more of the press coverage and a growing percentage of total market gains… The increasingly optimistic tone of press and TV coverage is also important. A mere six months ago, new market highs were hardly mentioned and learned bears were featured everywhere. Now, the newspaper and TV coverage is considerably more interested in market events.”

He continues:

“Other items worth mentioning are IPO windows and new record highs for corporate deals. We can have a satisfactory melt-up without them, but still one or the other is likely and both together are quite possible. I believe their presence would make a spectacular bust that much more likely.

Finally, my favorite advice once again: Keep an eye on what the TVs at lunchtime eateries are showing. When most have talking heads yammering about Amazon, Tencent, and Bitcoin and not Patriot replays — just as late 1999 featured the latest in Pets.com — we are probably down to the last few months. Good luck. We’ll all need some.”

h/t: StreetAuthority

— The Option Specialist

You May Also Like

About the Author: The Option Specialist