When the ‘Melt-up’ Melts down

When the ‘Melt-up’ Melts down


Editor’s Note:
We are very privilaged here at The Daily Reckoning Australia to have exclusive access to a wide and diverse range of resources and connections with our partners in the States. When I see one of our global analysts on the ground offering valuable insight, we’ll share it. Here’s my colleague Greg Guenthner on why the market could go parabolic.

Greg Guenthner

 

Barron’s is trying to ruin the bull market’s positive vibes.

Last month’s dreary ‘bull skull’ cover story threw some serious shade at stocks, followed by a laundry list of scenarios that could halt this bull market in its tracks.

This week’s edition takes that idea to the next level. It tackles the biggest one-day market meltdown in history: Black Monday. Even worse, the hypnotic cover story forecasts computer-driven trading programs will cause the next terrifying market crash…

Barron's
The proliferation of computer-driven investing has created an illusion that risk can be measured and managed,’ the article explains.

But as Marketfield Asset Management CEO Michael Shaoul says, ‘The system is more fragile than people suspect.’

This week is the 30th anniversary of Black Monday: 19 October, 1987. Fair warning: You won’t be able to avoid the endless 1987 coverage this week. The financial media is already bombarding us with stories of the Dow’s soul-crushing 22% drop.

The hubbub is also giving the crash-callers one more reason to invoke the ghosts of

Black Monday in their spooky market predictions…

Back as early as 2013, the doom brigade contended that the market was headed toward another abrupt crash much like we experienced in late 1987. The stock market has paid no mind to these dreary prognostications. While stocks have experienced the occasional hiccup over the past five years, nothing close to the Black Monday rout has reared its ugly head.

The major averages are back to their old tricks in 2017. Stocks are marching higher in lockstep formation without a hint of worry from the herd. The S&P 500 hasn’t produced a measly 5% pullback in more than a year.

With the market ripping higher every week — and Black Monday’s anniversary at hand — it doesn’t seem like a stretch to prep for a crash.

That brings us to our big question:

Is a 1987-esque meltdown possible sometime in the future?

Of course.

But it’s a worry that doesn’t have to dominate your investing strategy right now. Let’s take a quick peek into the past to see why…

First, we should put the 1987 crash into its proper context. It’s important to remember the crash itself was preceded by an extremely powerful rally that demanded a hard reset.

The bull-run that began in January 1985 sparked an incredible rally lasting more than 30 months. Investors were practically drowning in gains. The Dow Jones Industrial Average jumped more than 125% in the two and half years leading up to the crash.

And half the total gains were logged between January and August of 1987.

Chart 1
Source: StockCharts
How does a runaway market like we saw in the late 1980s compare to what’s happening right now?

I know it feels like today’s market conditions are just as powerful as what investors witnessed in the late 1980s.

But if we look at the performance the major averages have posted over the past three years, we see an entirely different picture.

While we’ve enjoyed an impressive rally over the past 11 months, it doesn’t even come close to equalling the power of the 1985-87 romp. A stealth bear market ripped apart stocks for the better part of 2015 and early 2016. In fact, we didn’t see anything resembling a strong rally until beginning the November 2016 melt-up.

Chart 2
Source: StockCharts
But maybe the Dow is poor measure of market euphoria these days. After all, it’s 2017.

Technology stocks are pulling the strings in today’s market.

Yet even if we replace the Dow with the Nasdaq Composite in our example, we’re looking at returns of 39% over the same timeframe. Make no mistake, 39% returns over a little less than three years is nothing to scoff at. But to compare today’s action to the 1985-87 melt-up is a bit of a stretch.

Bottom line: I’m not seeing the insane conditions we would need for a blow-off top right now. The action we’re seeing in the major averages looks like a steady grind higher rather than a major top.

Actually, today’s market reminds me of 2013.

At the time, the market had generated some newfound interest from retail investors.

Everyone and his brother was warning about a market top, that too many retail investors were buying in.

The conditions we’re experiencing in the markets right now are very similar to the market’s behaviour in 2013.

The truth is investors have been on the run from stocks since the financial crisis,’ I wrote four years ago. ‘The market’s definitely attracting some new money this year — but it’s not the climax of years of mom and pop investors piling into a red-hot market.’

No, history doesn’t repeat. But it does rhyme.

While the S&P 500 is up over 15% year-to-date, it was up almost 20% during the first seven months of 2013.

Despite the difference in magnitude, both 2013 and 2017 are strong trending years for the major averages. After slipping lower in August, the S&P enjoyed an epic fourth-quarter run in 2013 that helped it finish the year with gains approaching 30%.

Could this happen again in 2017? Absolutely.

Barring some unforeseen disaster, the major averages will easily finish the month with year-to-date gains intact. The S&P 500 is up over 15% year-to-date, like I said, and sitting at all-time highs. The NASDAQ is up over 22%.

Volatility is dead and buried. Manic market swings are no more. In fact, the craziest thing about this year’s market is that it’s one of the sanest investing environments of all time.

The S&P 500 has not rattled investors with a 2% move — up or down — at all this year.

The last time that happened was 2005.

So yes, markets have enjoyed smooth sailing in 2017.

When one group of stocks takes a hit, investors flip the script and shift their money to different sectors.

Bull markets spin from one hot group of stocks to the next. Any weakness in one area is concealed by the next group of winners.

The result is a trader’s paradise. When one trend begins to stall out, there’s always another hot trade waiting in the wings.

Of course, investors will probably have to deal with a pullback sometime over the next several weeks or months. Shaking out some of the weak hands is fine with me. But I don’t see any huge warnings signs popping up just yet.

It wasn’t time to sell in 2013 as the ‘dumb money’ piled in. And it isn’t time to cut and run now as the major averages remain up double-digits on the year…

The trend continues to tell us that consolidation periods and corrections are buying opportunities. Until this message changes, you should feel comfortable seeking out new investments.

Bottom line: It’s been a great year to own stocks. And we could very well see a strong market melt-up in the fourth quarter.

Prep for a potential melt-up while you have the chance.

Regards,

Greg Guenthner,
For The Daily Reckoning