The Dow could be so hot that it melts
Just like with ice cream and wine, too much of a good thing for the stock market could eventually become a bad thing.
The stock market is clearly on fire right now. The S&P 500 is poised to close at an all-time high on Thursday for the sixth day in a row. That hasn’t happened since June 1997, according to LPL Financial.
The Dow, on track for its 63rd record high since the election, is rapidly approaching the 23,000 level for the first time ever. Keep in mind, the blue-chip average sat at 18,333 on Election Day.
These stellar gains look amazing for your 401k portfolio (and President Trump’s Twitter feed), but some worry the market is on the verge of overheating.
“Right now, it feels like the early stages of a melt-up,” said Ed Yardeni, president of investment advisory Yardeni Research.
Everyone knows market meltdowns are scary. But “melt ups” are dangerous too. These relentless, unsustainable market rises end in tears because they aren’t supported by fundamentals — the economy and corporate profits.
“Melt ups are irrational. Too much of a good thing, too fast. It has to be followed by a meltdown,” said Yardeni.
Jeffrey Saut, chief investment strategist at Raymond James, is growing worried about the red-hot market, too.
The stock market “appears to be involved in a ‘melt up,'” Saut wrote in a research report published on Tuesday.
CNNMoney’s Fear & Greed Index is signaling euphoria right now. This gauge of market sentiment is flashing “extreme greed” at a level of 94 out of 100.
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Of course, doubts about the eight-year bull market are nothing new. Skeptics have been proven wrong time after time.
And there are legitimate reasons for the party on Wall Street. Interest rates, which are used as a yardstick for stock prices, remain historically low. That makes stocks look like a bargain by comparison.
The market really took off after Trump’s election, as investors celebrated the pro-business parts of his agenda — tax reform, deregulation and infrastructure — and largely ignored the less business-friendly aspects like trade and immigration.
Trump’s economic agenda has yet to get through Congress, but the stock market has been carried higher by strong corporate profits and a healthy economy both at home and abroad. Some expect that trend to continue.
“Growth in the world will be better than people give credit — and for a longer period of time,” said Rick Rieder, who helps manage more than $ 1.2 trillion in fixed income assets at BlackRock.
Related: The stocks set to win under Trump’s tax plan
Still, the sheer pace of the market’s gains give some people pause. Each time the market retreats a bit, it bounces back almost immediately.
“We continue to think the ‘buy the dips’ mentality is about to get blown apart,” Saut wrote, “but right now that view looks to be wrong-footed.”
Jeffrey deGraaf, co-founder of Renaissance Macro Securities, worries that the economy may eventually overheat. That could force the Federal Reserve to end the party on Wall Street by rapidly raising interest rates.
“We’re on the verge of being in a melt-up stage, fueled by excessive credit and a timid Fed,” deGraaf wrote in a report on Wednesday. He warned that credit is “so loose” that may be “starting to blow bubbles.”
Unfortunately, it may not be clear that the market is melting up until it’s too late.
Yardeni advised keeping an eye on a popular valuation measure: the forward price-to-earnings ratio of the S&P 500. That metric currently sits at 18.7, which is high by historical standards. If it climbs above 20, that may be a sign of trouble, Yardeni said.
“It could be similar to 1987 when the market had a really strong year, until everything fell apart in October,” Yardeni said, alluding to the infamous Black Monday market crash.
If stocks do take a tumble, even a minor one, deGraaf said he’s not sure what the catalyst will be.
“What’s going to derail this? I have no idea,” he said. “But it’s never the shot you see coming that gets you.”
