Is it a “melt-up”?
That’s a (silly) question that comes up whenever equities summit fresh peaks during a push that feels inexorable.
Belabored attempts to define the term notwithstanding, there’s no set definition of a “melt-up”. Asking if a given rally counts as a “melt-up” is like asking if an exhilarating college basketball game counts as a “barnburner” – you’re tempted to say “yes”, but if anyone asked you to make a definitive list of the characteristics a given game must exhibit to count as a “barnburner”, you’d probably come up short.
That said, any adjective that conjures ebullient sentiment will probably work for equities right now. They’re overbought and the VIX, while not returning to the halcyon days when fairy godmother was still running the show, has receded to levels below the 2018/2019 average (top pane).
The S&P is trying for a 12th weekly gain in 13, a streak which can quite fairly be described as silly.
If it strikes you that now is the time for caution, Wells Fargo’s Chris Harvey wouldn’t totally disagree. “Sentiment is too darn high”, he writes, in his year-ahead outlook for US equities. “More people are talking ‘melt-up’ than recession”.
That visual makes a simple, but powerful point. “It was not long ago (3Q19) when an inverted yield curve sparked concerns of a looming recession and created a great buying opportunity”, Harvey writes. “Now we think the opposite is true”.
The allusion to mid-August (when recession fears spiked and the 2s10s inverted) and the juxtaposition with where sentiment stands a scant four months later, reminds us that things are not always as they seem.
As JPMorgan’s Josh Younger observed after yields plunged in August, “the magnitude of convexity hedging YTD was likely the largest of the post-crisis era [and] fundamentals explain less than half of the move in rates and inversion of the yield curve in recent weeks”.
That created something of a “false optic” recession narrative, something we pounded the table on relentlessly at the time. Bonds were not “saying” what it sounded like they were “saying” – rather, past a certain point, investors were “hearing” mortgage investors and banks chasing the decline in yields, not fundamental bond buying based on a worsening outlook.
In any event, here we are at the opposite extreme – with “melt-up” trending and “recession” mentions haven fallen by the wayside.
And yet, even as Wells Fargo’s Harvey thinks this might be a good time to harvest some of the cyclical gains associated with the melt-up (or whatever you want to call it), he’s not overtly bearish.
“History and fundamentals suggests aggressive multiple expansion or EPS growth is not in the works for a melt-up but the economy isn’t bad enough to signal melt-down”, he writes.
His SPX target in 2020 is 3388 – pretty good upside, but hardly a “barnburner”.