Have Calls for a Stock Market Melt-up Already Been Answered?

by The Curmudgeon and Victor Sperandeo


One of the CURMUDGEON’s colleagues- an unnamed Finance Professor living in NYC-recently asked if I was “ready for a speculative blow-off? “   That same day (Monday), I was astonished to see how many analysts and journalists were talking about the very same thing-a “stock market melt-up.”   While old timers who’ve lived through many bear markets have an appreciation for risk, today we have incredible investor complacency that’s prevailed over the last two years of correction-less market action.  


There hasn’t been a significant market correction — defined as a drop in average share prices of more than 10 percent — since a 19.4 percent decline in the S&P 500 in September 2011.  Since the start of 2012, the market has never been in negative territory for a calendar year.  That has proven frustrating for those waiting for a correction to go long.  You can read an interesting perspective of Stock Market Corrections here.


There are many signs that investors are no longer worrying at all about the possibility of another stock market meltdown –like the one that occurred after Lehman Brothers was allowed to go bankrupt in September 2008.  A global financial crisis and recession brought the economy to a perilous state in late 2008 and the first quarter of 2009.  But for several years now, the Fed and other central banks have been flooding the world with liquidity, as the CURMUDGEON has pointed out in numerous posts.


One widely followed gauge of market sentiment, the Investors Intelligence Bull/Bear Ratio, soared last week to 3.19 from 1.96 two weeks earlier.  Ratios of 3.0 or higher have often signaled the onset of corrections or bear markets.  And bears have gone into hibernation. The percentage of market bears fell to 16.5 percent, the lowest since May 2011.


Survey of Market Melt-Up Worry Warts:

In his most recent Sunday NY Times column- The Dangers of a Stock Market Melt-Up Jeff Sommer wrote:  “Investors keep bidding (stock) prices higher and higher, with a speed and consistency that troubles Ed Yardeni.”   “I expect the market to rise,” Yardeni said. “But I’m worried that it could just go through the roof. If it does that, we could have a nasty correction afterward, maybe a bear market, and that could cause serious problems for the economy.”


Ed Yardeni isn’t the only longtime bull to note the possibility of a stock market melt-up. Laszlo Birinyi, an independent strategist based in Westport, Conn., did so in his current newsletter, called Reminiscences. “Historically, bull markets of this length and strength have a period of exuberance,” he said. “It doesn’t have to happen but it usually does and we would certainly leave the door open for what is termed a melt-up.”


Also this Monday, Yahoo Finance released a video titled: Forget a Meltdown, Beware a Market “Melt-Up”?  It’s quite provocative and entertaining (if you can detach from the irrationality behind the current stock market advance).


But what really caught my eye was a piece by the granddaddy of all market newsletter writers- Richard Russell of Dow Theory Letters.   In a November 5th note to subscribers, Russell wrote:

“Despite the sluggish GDP, I believe you will see a third phase speculative blow-off in this bull market.  Often in a bull market’s third phase, profits are larger than anything seen during the first and second phases of the bull market.  For this reason, my current thinking is that subscribers should hold gold and DIAs.  The last thing investors are expecting now is a profitable third phase explosion in stocks, and perhaps something close to hyperinflation in the money market.”

“I believe you see a phenomenon where increasingly bullish retail buyers are coming into this market, while at the same time institutional money is taking profits and moving to the sidelines.  I expect this action to accelerate in the coming months, leading to an upside boom in stocks, along with a good deal of churning action.  It is now recognized that the forces of deflation are pressing down on the US economy, and that more QE will be needed.  This will halt deflation and gradually lead to inflation, finally being expressed as a boom in the stock market.  Thus the great bull market will end as all bull markets do: with a massive entrance of the retail public and subtle distribution by institutional money.”


Haven’t We Already Had a Melt-up?


The CURMUDGEON has often called attention (Small Cap Stocks Bubble Despite Weak GDP and Modest Earnings) to the outperformance of small stocks- led by the RUSSELL 2000 index (RUT), which is up over 40% since November 16, 2012. We’ve also noted the many small cap mutual funds that are up over 40% YTD. 


According to the WSJ, RUT sports a trailing P/E of 87.4 as of Nov 1, 2013, which is triple its P/E of one year ago!  Doesn’t that qualify as a melt-up?  If not, how much further does RUT have to rise to justify melt-up status?


Closing Comment by Victor Sperandeo:


I started as an option's trader in 1968 with Filer Schmidt and read the tape to forecast the markets. I used Dow Theory along with many technical indicators and was pretty successful. Sadly, those tools and metrics are now 99% worthless.


Any fundamentalist, value approach, and most quant algorithmic trading strategies have not worked well in this market. Why not? Because this is not a "free market!"  Instead, it is a manipulated market, controlled, and created by Fed Chair Ben Bernanke- a university professor who never traded stocks/bonds or worked in business a day in his life.

As a result, history is worthless in analyzing this market. If the Fed stops printing $s the markets will surely decline aggressively. The equity markets will also react negatively to a crash of the U.S. dollar, as the CURMUDGEON has pointed out in several previous posts.  


Till next time........................


The Curmudgeon

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1979) to profit in the ever changing and arcane world of markets, economies and government policies.  As President and CEO of Alpha Financial Technologies LLC, Sperandeo overseas the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.