A Market 'Meltup': Sizing Up the Chances

The suspense is growing. As traders enter the homestretch of the year, is there room for one last rally?

Another run could depend on a so-called “meltup,” a term you’ve probably heard spouted repeatedly on business television. Although it’s not a tool in the belt of individual investors, it can influence their portfolios and their investing decisions.

A meltup is a self-perpetuating rise in stocks that occurs as institutional investors chase returns. It’s a game of catch-up they play after waiting too long to go long and, as a result, underperforming the major averages. As these investors pour money into the market to catch last-minute gains, stocks rally to levels that fundamentals rarely seem to support.

“What happens is you’ll see people sitting on the sidelines, buy-side firms, they’ll let the market take its course by hedge funds and momentum traders,” says Anu Sharma, managing director of the market intelligence desk at Nasdaq. “But if they start to lag performance, these buy-side firms will come in aggressively.”

Whether we see another meltup will be dictated by what we see in the next month or so, Sharma says. “It will be the hedge funds and momentum traders – whether they are driving performance, while the buy side sits on their hands.”

So just how likely is it? There’s a strong possibility, according to Ryan Detrick, senior technical strategist at Schaeffer's investment research. “We still know we’re up significantly year to date,” he says. “Nonetheless, we know the majority of mutual funds and hedge funds are trailing [performance].”

And the timing is right. Over the past six months, every time the major averages have dipped to their 50-day moving averages, buying followed that led them to new highs. Notably, in the past few weeks, the major averages have broken below this metric.

Sure, it looks like the same old trend, Sharma says. “I think we’ve seen the retracement that we’ve needed to see, and now the market is going to try to make another run for it. But the market is slowly running out of steam, and the volumes aren’t dictating that we can make another big run.”

There’s also some concern because the averages didn’t just come near the lows, they broke through them, which alone could trigger a break in the pattern and could mean the major averages aren’t due for another round of highs just yet.

“While we believe that the primary uptrend in stocks remains intact, our analysis now suggests that the market may not be able to handle the truth in the short term and should test support at lower levels,” Richard Ross, chief technical strategist for Auerbach Grayson, wrote in a note earlier in the week. “The important violation of the 50-day moving average has earned our respect.”

Factor in a 57% increase in the CBOE volatility index, which is considered a reading on fear in the market, and Ross believes a more cautious approach is warranted.

A recent poll showed only 22% of individual investors surveyed were bullish, the lowest number of bulls in eight months, says Schaeffer’s Detrick. But his firm uses that poll as a “contrarian indicator,” which means it expects those individual investors will be wrong. So a meltup, or even an increase on fundamentals, may yet be on the way, he says. The last time the poll showed investors to be this bearish was March 5, and “we all know March was a really good time to be long,” Detrick says.

“As long as we can stay above the October lows on the S&P 500, you have to give the bulls the benefit of the doubt,” he says.