Is This a Market Melt-Up? Here Are Some Ways to Tell: QuickTake

(Bloomberg) -- Once again, stocks are hot. Following a drubbing earlier in the year, benchmark indexes are setting new records as investors ignore warning signs and keep piling in. Is this another rally justified by robust earnings, lower taxes and less regulation? Or is it something that rings alarms, a melt-up? Here’s the difference.

1. What does melt-up mean?

You won’t find it in a dictionary. It’s a term traders use to describe a specific market event: a rapidly accelerating rally driven purely by sentiment. That is, market optimism has come untethered from fundamentals, and investors are chasing returns by jumping on an upward-moving bandwagon. It’s all based on momentum and, in its later stages, fear of missing out. At its most extreme, it resembles panic buying -- or the panic selling found in the more familiar market meltdowns.

2. What classifies something as a melt-up?

There’s no exact criteria, but the term is most often used when a market has gone from steady gains to increasingly rapid ones. Consider recent history: U.S. stock advances were steady and fairly slow during the six-month slog back from February’s market correction, but in just the past two weeks alone the S&P 500 Index has rallied 3 percent to an all-time high, bursting past the 2,900 level for the first time. The surge has taken it within a whisker of overbought territory, harking back to levels last seen in January before the rout.

3. Have we seen melt-ups before?

Sure. The dot-com bubble in 1999 and 2000 is a classic example. Prices soared, and investors rode the momentum, while growth in earnings fell way behind growth in share prices. There was no solid foundation to go along with the optimistic expectations, which meant that the run-up amounted to a stock market bubble -- and crash.

4. So is a melt-up the same as a bubble?

No, they’re not synonymous. And again, fundamentals -- or the lack thereof -- are the key. A melt-up can push prices into bubble territory if the surge gets out of whack with things like earnings and sales. But if those catch up to price performance in a reasonable amount of time, it’s possible a bubble would be avoided. In fact, in hindsight it would look like a justified rally -- smart money getting ahead of a trend. The big rallies of 2009 and 2010 are examples.

5. Are we seeing a melt-up right now?

Well, the investors driving up prices are betting this is no melt-up -- or at least that the surge will continue long enough for them to get out in time. And buyers can point to tangible underlying reasons for the optimism, including the impact of the U.S. tax cuts this year, the strongest economic growth since 2014 and a second-quarter earnings season that saw more than 80 percent of S&P 500 members beating analysts’ forecasts. Wall Street’s biggest cohort of bulls has ratcheted up estimates for where stocks will end the year, with Barclays Plc and Weeden & Co. now expecting the S&P 500 to hit 3,000, giving the equity benchmark a 12 percent gain for the year.

6. Where does the term come from?

Melt-up is a play on meltdown, which, according to Merriam-Webster, emerged in the 1930s as ice-cream industry jargon "to describe the rate at which ice cream returns to a liquid form." By the 1950s, the word "had begun to be used in reference to ‘the accidental melting of the core of a nuclear reactor,’ and now can also refer to any general rapid and disastrous decline." Like that of an overtired toddler whose ice cream has melted, or a market that suddenly realizes that a melt-up is melting away.

The Reference Shelf

• Melt-ups are coming back to the forefront for investors.
• President Trump’s corporate tax overhaul is the gift that keeps on giving.
• U.S. stocks are “the place to be,” LGT Bank Asia says.
• Is stock overvaluation a chronic problem?
• Could the bull run in equities be just getting started?
• U.S. stock investors are betting on a big move -- in some direction.
• Bloomberg’s Michael P. Regan on FOMO and melt-ups.

To contact the reporters on this story: Kailey Leinz in New York at kleinz1@bloomberg.net;Luke Kawa in New York at lkawa@bloomberg.net

To contact the editors responsible for this story: Chris Nagi at chrisnagi@bloomberg.net, Brendan Walsh, Laurence Arnold

©2018 Bloomberg L.P.