Seeking Alpha

Could We Be Heading For A Melt-Up?

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Includes: BXUB, BXUC, DMRL, EPS, IVV, PPLC, RSP, RVRS, RYARX, SDS, SFLA, SH, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SSO, UPRO, USMC, VFINX, VOO
by: Future Growth Investor
Summary

We've seen a huge run-up in the market since 2009.

A melt-up is the exuberance of a market before the inevitable meltdown.

Should we be preparing ourselves for the worst?

Firstly, I have to apologise for my inactivity the past nine months. Medical school doesn't really leave much time for anything else unfortunately, but I've found myself coming to the end of my third year and I've found the time and inspiration necessary to start writing again. It's been a very interesting time in the market and I've still been adding to old positions and starting new ones as well, and hopefully I'll get to writing a few articles about my buys soon. And a special thanks to my old and new followers, without whom I'd find it that little bit harder to get back to helping us all try understand a little about the stock market!

A funny thing some medical students I know saying jokingly is "fake it, till you make it." The amount of knowledge and experience needed to succeed as a doctor is sometimes overwhelming to the mere student, so 'faking' it until we know enough to actually know what's going on is an act some medical students practice at sometime during their studies. But how does this relate to the stock market? Well, what if the market is 'faking' it? By that I mean are things less rosy than they seem to be? Do the market fundamentals support near all-time highs?

So what's all this about a 'melt up'? Enter legendary value investor Jeremy Grantham, the Boston-based founder of GMO, an asset management firm with $118 billion of client funds. Grantham is well known for his identifying speculative bubbles and avoiding crashes before any else knows what's happening. He famously spoke of bubble conditions in Japanese equities and real estate in the late 80s as well as advising his clients away from the DotCom bubble of 1999/2000. He has also studied dozens of bubbles and meltdowns and warned of both decreasing profit margins and a fall in the housing market in September 2007, one month before the market peak preceding the Global Financial Crisis. In a 2010 client letter, Grantham wrote "Every single [bubble] has broken all the way back to the trend that existed prior to the bubble forming."

What does Grantham mean by a 'melt up'? He believes we're seeing the last stages of a great bubble near to bursting, where the market will rocket up before the inevitable meltdown when the bubble bursts. And though it pains me, I can see where he's coming from (though I'm not pulling my money out of the market for now, just keeping some dry powder on the side). We see Netflix (NFLX), Tesla (TSLA) and other companies that don't make a profit at their highs. We see large caps such as Johnson & Johnson (JNJ), Tiffany & Co. (TIF) on large PEs in comparison to their growth. There doesn't seem to be much value to be found in the current market.

Source

A note from Bank of America Merrill Lynch (BAC) shows that since 1930 the U.S. stock market has dropped by at least 5% an average of three times a year. Prior to the Jan/Feb gyrations, the market hadn't seen such a decline since June 2016 so we are definitely due for a drop, but how big a drop is the main question. Since October 2016 the S&P 500 (SPY) (VOO) has only really seen one-way traffic, the index continually rises despite apparent Russian meddling in U.S. elections, White House craziness, Chinese debt problems, the threat of nuclear attacks and earnings misses. In October 2017, Bloomberg reported the Nasdaq had finished at all-time highs 62 different times by that point in the year - equal to the most ever in 1999. And we all know how that ended.

Grantham wrote in his January 3rd investor letter "The psychology of a bubble can be incredibly painful for asset managers with careers at stake. In normal times it’s reasonable to believe clients are concerned about how well a manager can handle a downturn. But in a bubble, forget it, clients care much, much more about underperforming all their friends on the golf course."

"While everyone is bragging about their gains, sitting on a pile of cash can cost asset managers their clients, so many managers stay invested. They’re leaping around with great energy, comparing notes," says Grantham. "They simply can’t stand that one or two of their rivals are playing the game and making a lot of money and making them look bad."

If you do what everyone else is doing, even if you all run off the cliff at the same time, you typically don’t get fired.

This is why we, as individual investors have an edge over the 'big boys' on Wall St. We have the power to control ourselves as we get to the possible end of the long running bull market. As I wrote in my last article last July: "This doesn't mean I'm pulling all my money out of the market and running to put it in gold (or under my mattress). I've made numerous investments in the last year, fully aware that a correction could be around the corner. And I continue to carefully allocate money to great long term investments, even though I have half an eye on any downturn that may occur...That said, I am holding a sizable amount of cash in anticipation of any big drops that may occur in any of my portfolio stocks, or stocks on my watchlist. Big drops, crashes, corrections and recessions are a long term investor's dream as we can pick and choose great stocks that are selling for lower than normal prices because of market-wide selling and panic.

Long term investors need to be ready for a market drop, no matter how large, by keeping some cash on the side. But we shouldn't be scared to buy great quality companies now, especially if we can find any at inviting prices. Most importantly, we need to mentally steel ourselves to buy if we see any 'blood in the street', as any large discounts in quality stocks would be an opportunity not to be missed."

Source

Author's note: Thank you for your time and please comment if you have any suggestions for future articles or other thoughts! Please follow me at the top of the page if you're interested in reading more articles about my portfolio, my watchlist, or my investing world, and to keep up to date with the companies I cover. I hope to continue outlining my portfolio and highlighting the stocks I hold in future articles to help the Seeking Alpha community in finding and researching investment-worthy companies.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.