Are We At Risk Of A “Market Melt-Up”?

bullShould we be worrying about a market melt-up?

That’s when the stock market keeps moving upward at an unsustainable pace as a result of excessive market optimism, especially among the base of “mom-and-pop” retail investors.

Several prominent investment strategists, while they remain generally bullish about the case for stocks, have gone on the record lately to express their worries about market frothiness.

“We’re in a bull market, and I think it can continue for the next few years,” said Ed Yardeni in a New York Times interview.  But what concerns Yardeni is the “growing complacency of his fellow investors … who keep bidding prices higher and higher, with a speed and consistency that troubles him.”

Investors should be more concerned, he says, about the weakness in the world economy and what will happen when the Fed eventually removes its monetary life support.

Charles Schwab investment strategist Liz Ann Sonders (a speaker at last week’s Schwab Impact 2013 conference that I attended) echoed the same warnings. She says the risk of a melt-up in stocks is garnering more attention, although there are few, if any, bubble-like conditions present and fundamentals otherwise appear healthy. “Sentiment does appear stretched in the near-term,” she observes, and warns of a possible pullback.

What is a big warning sign flashing in the eyes of these market experts?

They say the “dumb money” is getting increasingly confident, and when the mass of retail investors (what they call the “Mom and Pop” investors) starts buying stocks, they worry it’s time to run for the hills (editorial note: I’m sure many of those “dumb” investors question that term, especially when coming from those “smart” institutional investors who managed to lose billions on bad investments in 2008!).

Retail investors have poured over $76 billion into stocks this year, not necessarily a bad thing given zero rates offered by banks and the tough environment facing bonds. But it is fair to say that excessive public enthusiasm for stocks – which we are perhaps seeing now – is often viewed as a contrarian indicator and a warning sign.

What would be healthier for this market?  Many of us would welcome a pullback that makes stock prices more affordable and injects some worry back into the system.

Greg Valliere, chief political strategist at Potomac Research Group (also a keynote speaker at the Schwab Impact 2013 meeting), agreed that a pullback would be welcome.

“Retail investors may be rejoining the party — and when that happens, a correction is usually within sight,” he said.

In fact, the market hasn’t suffered a 10% correction since 2011, which makes it overdue.

How should you deal with these market melt-up worries?

  • One approach we follow is to move large sums of money into the market a little more slowly and try to favor cheaper and out-of-favor corners of the global stock market.
  • Understand that risk is always a component of investing, and expect (and perhaps even welcome) temporary pullbacks for the opportunity they give long-term investors to buy more cheaply.
  • Don’t chase performance, and be happy if your returns are lower than “hot” market averages. That usually means you’re well-diversified and avoiding some of the hyped up and frothier markets, and focusing your investment dollars on more defensive sectors. I still remember one couple complaining about their “slim” 22% returns on the eve of the 2000 tech bubble.  Instead of celebrating the investment sanity in their portfolio, they regretted lagging the market. You can be assured that one year later they were seeing things a little differently, and breaking out the champagne to celebrate the huge investment melt-down they avoided!

 

About Mari Adam

Mari Adam, Certified Financial Planner™ and President of Adam Financial Associates Inc, has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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