Melting Down or Melting Up?

May 8, 2017

The market continued to touch new highs this past week. For some this might be the time of greatest personal wealth on paper, especially those with a large allocation to U.S. stocks. The key question during times like this is: how high can the markets go? Of course, nobody can answer that question, but this seems like an appropriate time to consider a market term not often used, a market “melt up.”

Let’s start by looking at terms applied to downward market movements. As we all know, a market meltdown is financially and emotionally draining for an investor. It is a time when it feels like the market is trading into a downward vortex. Another colorful, yet less painful term for a selloff in the market is a “pull back.” A pull back in the market is typically discussed in terms of a 10% to 15% decline.

So what is a market melt up, and what does it look like?  A melt up occurs when a market that has been trading continually higher turns into a turbo charged juggernaut on the upside, without any relation to underlying fundamentals. It is the time when investors with cash decide to invest to make sure they do not miss out on the market’s rise. Valuation models are thrown out the window as these exuberant investors buy, and then buy some more. The last stages of a long bull market can sometimes see a melt up, which takes valuations to unheard of levels. This melt up is then inevitably followed by a meltdown.

Markets that are cited as classic melt ups include the Dot Com Bubble in 2000, the US housing market in 2008, and the Japanese stock market in the 80s. With regard to the latter, the Japanese market enjoyed a twelve year rally, which started at a level of 3,400 in October 1974, and moved to 17,457 by August 1986. Over the subsequent three years, from August 1986 to December 1989, it went into full melt up mode, raising up to 38,700! The Japanese market then crashed in 1990, and 26 years later has still not fully recovered.

The common theme in these melts ups is a relatively quick run up in value, which is fueled by new money from investors who feel like they must buy the market. That sense of urgency does not appear to be in this market, as both corporations and individuals are still sitting on record amounts of cash. For example, just this week Apple and Warren Buffet reported that they have over $230 billion and $90 billion respectively in cash. This market might not experience a melt up before it corrects on the downside, but the behavior of market participants should be tracked with a watchful eye to see if there are any signs of a move to melt up mode. These are interesting times.

Carl Gambrell