Don’t look now but as of the time I’m writing this post, US equity markets are fast approaching new all-time highs. I know – that is hard to believe after what we went thru just a few months ago. The recovery off the April lows has been staggering – yet remains a very hated and untrusted rally based on the general sentiment of “the street”
A strategist this week commented that this ongoing equity strength – in the face of a meaningfully negative plurality of investors (such as record short positioning by hedge funds, declining margin debt, and investor sentiment surveys showing more bears than bulls) – could lead to a “melt up” rally. I discussed this term with a client and thought it was worth looking at together.
It’s really as simple a definition as it seems. We’re all familiar (unfortunately) with the term meltdown – whether it be from personal experiences (come on, we’ve all been there!) or from market experiences (think back to early April if you dare!). Well, a melt up, or more specifically a melt-up rally, is the opposite dynamic. It’s a sharp and sustained increase in the price of an asset (or market). Things change shockingly fast and there are many carry-on effects – but in the case of a melt-up, they are favorable .
Typically, melt-up rallies become self fulfilling prophecies in a hurry – as the rally starts to take hold (keep in mind, it usually happens relatively quickly), more and more investors panic that they “missed it,” and rush to buy in. This is further exacerbated by short positioning – which requires stocks to be purchased in order to cover the short. All of this added demand drives prices up even further, leading to the rally continuing.
As I said, it’s a relatively easy concept to grasp. The harder thing to decipher is if we are about to enter one. Not to disappoint you, but that impossible to know. It certainly feels possible as positioning remains offside (meaningful amount of cash on the sidelines, high short interests, underweight to US equities, etc) – all while US markets steadily march higher and come within striking distance of all-time highs.
However, as we have learned from recent months, with the ongoing trade negotiations and political environment and negotiations (hello budget bill), and the general negative macro backdrop, we could also see a meltdown. Let’s hope that’s not the case – but it’s important to consider all possible outcomes and give them their appropriate probability weighting.
As always, the advice remains the same. Establish your plan, revisit it after there big market movements and rebalance as needed, and focus forward. If we see a melt-up, it may be a great time to trim some winner, rebalance if you need to, and celebrate. And if we don’t, stay on track and file the term away for future reference!
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