According to Investopedia, a Melt Up is a “dramatic and unexpected improvement in the investment performance of an asset class or broad market index, driven in part by a stampede of investors who don’t want to miss out on its rise, rather than by fundamental improvements in the economy.” The current record setting run in the equity markets seems likely destined to end the year in strong fashion, and in my opinion, fits this definition. The full year returns that will show up on December 2019 brokerage statements will be enhanced by the sharp sell-off the equity market experienced in the 4thquarter of 2018. But, even considering that fact, there is no question 2019 has been a good year for the broad markets, and some stocks have had spectacular runs.
So, that leads many investors to ask the question, “When will it end?
Of course, no one really knows the answer to that question. But, if I had to guess, I would say it will probably end with a bang – a sharp upward move to extreme valuations. But it very likely won’t be a straight line higher, and instead we will probably witness some gut wrenching volatility.
During the last great Melt Up in stocks – the dot-com boom – the Nasdaq Composite Index actually saw five roughly 10% declines during 1999 and early 2000 during its final push higher. When it finally peaked, the subsequent decline was sharp and painful. If you’re going to be invested in equities during a Melt Up phase, you’ve got to be able to stomach volatility.
So, how do you know when another increase in volatility and a potential sharp sell-off might happen? As Warren Buffett so famously said, “They don’t ring a bell at the top or bottom of investment markets.” But, there are short-term indicators and reports you can watch for clues. Let’s look at some of them, and what they are telling us now.
One is the CBOE 10 day put/call ratio.
This indicator compares how many put options investors are buying with how many call options they’re buying. And like other sentiment indicators, it’s contrarian in nature. When folks are piling into call options relative to put options, the CBOE’s put/call ratio drops lower. This tends to be a bearish sign. It suggests the crowd has gone “all in”… and at least a short-term pullback is potentially likely. The Put/Call ratio fell to a reading of 0.65 in the month of November. This is the ratio’s lowest extreme since January 23, 2018… again, less than two weeks before the S&P 500 plunged more than 10% in February.
Another indicator of short-term sentiment is the Investor Intelligence survey of newsletter writers. The latest reading (https://www.investorsintelligence.com) shows 57% of those surveyed expect the market to move higher in the near term. According to the firm, a reading above 55% has historically suggested a short-term peak could be forming. Like the put/call ratio, similar readings preceded each recent market correction.
Similarly, individual investors seem to finally becoming more bullish after maintaining a cautious stance for months. The American Association of Individual Investors survey (https://www.aaii.com/ ) shows they are as positive as they have been in more than a year. The group has more than 2 million users, so the survey is a good sampling of what the “herd” is thinking. The poll asks investors where they think the stock market is headed over the next six months. The recent readings mark the first time since the weeks of August 29 and September 5, 2018, that bullish sentiment was above 40% for back-to-back weeks and it’s the fourth consecutive week of bearish sentiment remaining below the historical average. These are contrarian indicators. When surveys show that most people are scared you should be optimistic and when they indicate an excess of optimism you should be cautious.
Given this combination of sentiment signals, it’s little surprise that news network CNN’s so-called “Fear & Greed Index” has suddenly surged higher. This index uses the put/call ratio, market volatility, and a handful of other measures to compute a score between 0 and 100. Levels below 50 indicate some degree of fear, while levels above 50 indicate greed.
As of recent readings, the index had risen to 87, well into “extreme greed” territory. This is up from 50 – or “neutral” – just one month ago. And it’s nearly a mirror image of this time last year, when the equity market was in the throes of a 20% decline, and the index sat at just 10, deep in “extreme fear” territory.
As a reminder, the long-term indicators of equity market strength, and the Fed once again increasing their balance sheet, likely mean the bull market could continue well into 2020 – absent some external shock. So, if you’re portfolio allocation is properly diversified in quality names and your position sizing is appropriate – and you are already holding some extra cash and own some gold, you can probably sit tight. There’s no need to do anything right now.
However, if you’re portfolio allocation is overly weighted in equities, or you’re holding a large percentage of your portfolio in speculative stocks today, and particularly if you’re among those who were stressing during last fall’s sharp decline, you might consider doing some re-allocation by taking some profits and raising a little cash today.
Randy has more than 15 years of experience managing financial assets for individuals, retirement plans and businesses. Randy joined YHB | Wealth Advisors in January of 2018 and serves as the Director of Wealth Management. Prior to entering the professional wealth management field, he enjoyed building entrepreneurial business ventures from start-up to eventual sale and providing accounting services for public and private firms.