Anatomy of a Meltup

As the S&P 500 continues to rise to new record highs, we are frequently asked how we define a meltup and are we already in one? One simple answer is that the S&P 500 is melting up whenever the S&P 500 forward P/E is rising much faster than S&P 500 forward earnings per share, suggesting mounting “irrational exuberance.” In his December 5, 1996 speech, Former Fed Chair Alan Greenspan famously asked, “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions .…” In a stock market bubble, investors must have very high expectations for earnings growth and very low risk assessments to justify the market’s lofty valuation levels. These assumptions might be irrational thus setting up the meltup for a meltdown, or at least a severe correction. 

Are we there yet? Hard to say, but we may be getting closer to that scenario. The stock market continues to ignore geopolitical risks, especially in the Middle East, and also domestic political risks as the US elections approach. In the former scenario, Hezbollah's attempt to assassinate Israel's prime minister over the weekend could up the ante in Israel's widely expected retaliatory response to Iran's missile attack a few weeks ago. Here at home, a very close presidential election could be unsettling if it is bitterly contested. On the other hand, a sweep by either party could lead to legislative successes for extremist policies with inflationary and deficit-bloating consequences. We are still rooting for gridlock.