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

(Bloomberg) -- Once again, stocks are hot. Following a drubbing late last year, benchmark indexes have been grinding higher as investors keep piling in, setting fresh all-time highs in the process. Is this another rally justified by dovish pivots from major central banks around the world, green shoots in global activity, and earnings results that are surpassing Wall Street’s expectations? Or is it something that rings alarms, a melt-up? BlackRock Inc. Chief Executive Officer Larry Fink said he thought a melt-up was a possibility, as money that had moved to the sidelines after a sell-off late last year headed back into the markets. Here’s the difference between something good and something that’s too good.

1. What does melt-up mean?

You won’t find it in a dictionary; it’s in the eye of the beholder. It’s a term traders use to describe a specific market event: a rapidly accelerating rally driven purely by sentiment, with high participation, volumes, and volatility. That is, market optimism has come untethered from fundamentals, and investors are chasing returns by jumping on an upward-moving bandwagon. A melt-up doesn’t give investors waiting to buy the dip any chances to get in -- 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 the start of 2018: after a year in which the S&P 500 Index steadily trudged ever higher -- with only a handful of daily gains of 1 percent -- stocks went bananas in January, fueled by tax-cut enthusiasm. The 5.6-percent monthly advance propelled the benchmark gauge above where many analysts predicted it would end the year, with a variety of metrics signaling that stocks were in technically stretched territory. The euphoria ended with a bang: Feb. 5 brought the biggest one-day jump in the equity market’s "fear gauge" on record, with exchange-traded products that let investors bet on enduring calm imploding.

3. Have we seen melt-ups before?

Sure. The dot-com bubble in 1999 and 2000 is a classic example. Prices soared, and volumes crescendoed as 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. 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

  • Long spans between records can be a bullish sign for stocks.
  • Debating the market melt-up narrative (video).
  • Hedge funds are joining the equity party.
  • FOMO running rampant in the stock market.
  • Stocks more likely to melt up than melt down, Fink says.
  • Investors are piling back into equity funds.

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