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Market Update: 02-05-18

MELT-UP OR MELT-DOWN?

John Lynch Chief Investment Strategist, LPL Financial | Jeffrey Buchbinder, CFA Equity Strategist, LPL Financial

Did stocks just melt-up, setting up a possible melt-down? Friday’s sharp decline, the biggest since the Brexit vote in June 2016, might have led us to forget that just a few days ago many claimed the stock market was melting up. The strong finish to 2017 followed by big gains in January certainly made this a reasonable characterization. (Though we continue to believe stock valuations are well supported by fundamentals here.) Concerns have now turned to whether last week’s sell-off is the start of something much bigger, or dare we say a meltdown. This week we discuss whether stocks have melted up or if they are about to melt-down.

DID STOCKS JUST MELT-UP?

There is no standard definition of a melt-up, a phrase used to describe a sharp and swift move higher in the stock market (think late 1990s). The logical implication of a melt-up is that stocks are stretched and poised to fall. Our friends at Strategas Research Partners have defined a melt-up as a top five percentile rally in the S&P 500 Index within six months when the index is at new highs. Based on data back to 1985, the top five percentile of 6-month performance for the S&P 500 is 21%. The recent peak in 6-month rolling S&P 500 performance, on January 26, 2018, was 16%, well short of that breakpoint. Even if we assume stocks just melted up, it does not preclude further gains. Using the melt-up definition above, the S&P 500 experienced 13 of them since the mid- 1980s. If you bought the S&P 500 on all of those melt-up dates, you generally ended up doing well. The S&P 500 was up an average of 4% six months after those melt-up dates (median +6%) with gains...

Download the complete PDF with graphs here.

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