Melt-Up Definition How They Work Causes and Examples

Melt-Up Definition How They Work Causes and Examples

Melt-Up: Definition, How They Work, Causes, and Examples

Anthony Battle is a CERTIFIED FINANCIAL PLANNER™ professional. He earned the Chartered Financial Consultant® designation for advanced financial planning, the Chartered Life Underwriter® designation for advanced insurance specialization, the Accredited Financial Counselor® for Financial Counseling, and both the Retirement Income Certified Professional® and Certified Retirement Counselor designations for advance retirement planning.

What Is a Melt-Up?

A melt-up is a sustained and unexpected improvement in investment performance of an asset or asset class, driven by a stampede of investors who don’t want to miss out on its rise, rather than fundamental improvements in the economy.

Gains from a melt-up are considered unreliable indications of the market’s ultimate direction and often precede meltdowns.

Key Takeaways

  • A melt-up is a sudden, persistent rise in the price of a security or market, often due to investor herding.
  • Melt-ups are not necessarily indicative of a fundamental shift and may reflect market psychology instead.
  • Poor decisions to buy into a melt-up can be avoided by focusing on economic indicators that provide an overall picture of the health of the US economy or the fundamentals of a stock.

Understanding Melt Ups and Nuances of Economic Indicators

Ignoring melt-ups and meltdowns and focusing on fundamental factors begins with understanding economic indicators. Economic indicators come in the forms of leading indicators and lagging indicators. These are all forms of economic indicators that investors follow to forecast the stock market’s direction and overall health of the U.S. economy.

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Leading indicators are factors that shift before the economy starts to follow a particular pattern. For example, the Consumer Confidence Index (CCI) reflects consumer perceptions and attitudes that indicate future consumer spending, which accounts for 70% of the economy.

Additional leading indicators include the Durable Goods Report (DGR), developed from a monthly survey of heavy manufacturers, and the Purchasing Managers Index (PMI), a survey-based indicator that economists use to predict GDP growth.

Lagging indicators shift only after the economy has begun to follow a particular pattern. These are often technical indicators that trail the price movements of underlying assets. Examples of lagging indicators are a moving average crossover and a series of bond defaults.

Melt Ups and Fundamental Investing

Many investors attempt to avoid melt-ups and their impact on investor emotions by focusing on the fundamentals of companies. Warren Buffett, for example, is a famous value investor who made his fortune by carefully analyzing companies’ financial statements, even amid economic turmoil. He assesses corporate value and price, considers the company’s financial footing, management expertise, and whether the stock is over- or under-priced. These questions help investors focus on intrinsic value over hype.

Example of Melt Ups

Financial analysts saw the run-up in the stock market in early 2010 as a possible melt-up. Unemployment rates remained high, residential and commercial real estate values continued to suffer, and retail investors withdrew money from stocks.

During the Great Depression, more examples of melt-ups occurred as the stock market rose and fell multiple times despite a generally weak economy. Research by wealth managers showed that stocks fell over 80% between 1929 and 1932 but posted returns of over 90% in July and August of 1932, with the trend continuing over the next six months.

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