Marc Cuniberti: ‘Hope for the best but prepare for the worst’ — Navigating through market melt down’s and melt up’s | TheUnion.com

Marc Cuniberti: ‘Hope for the best but prepare for the worst’ — Navigating through market melt down’s and melt up’s

Marc Cuniberti
Columnist

Despite the recent brutal sell off in equity markets two weeks ago, the term "melt up" has appeared in many a financial commentary. Indeed the term appeared years ago by some prognosticators who predicted the trillions of dollars created by global central bankers to facilitate the myriad of bailouts required, (arguably) to stabilize the world markets after the 2008/2009 crisis, would eventually find its way into the stock market, driving prices to previously unheard of levels.

With the widely followed Dow Jones Industrial Average soaring from the mid 6,000s where it stood during the 2008 banking crisis to over 26,600 at its recent high, an argument could be made this quadrupling of the DJIA could be nothing else but the proverbial "melt-up".

From Investorwords.com, the melt up is defined as: "A dramatic upturn of certain stocks occurring when investors unexpectedly purchase these stocks and drive their price up without any specific reason, logic or improvement in economic conditions. A melt up reflects a mass mentality where it appears that investors do not want to miss out on making a possible profit. This is usually followed by a meltdown."

Wealth effect

Obviously the melt up portion of the equation is quite an enjoyable ride for investors as they see their portfolio values rising almost daily. What could be simpler right?

Such increases in stock valuations and their subsequent effect on investor perception of their new worth could also lead to the often touted "wealth effect." This wealth effect is based on the belief that with rising stock portfolios come rising optimism on behalf of investors and they will subsequently spend more, boosting asset prices even farther as companies reap the rewards of such spending.

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And around and around we go, upwards and onwards to the carefree life resembling the "Roaring '20s," a period in U.S. history that is said to be one of lavish spending brought on by the relentless rise in their markets between 1920 and 1929. During that time the nation's wealth reportedly more than doubled, only to fall victim to the great stock market crash of 1929.

Of course, the wealth effect is thought to kick in reverse when the opposite happens, mainly the stock market melts down. Such a thing happened in 1929 and has happened at various other times in history, not the least of which being our own crisis in 2008/2009, when consumer spending fell off the proverbial cliff, to put it mildly.

This is not to say, as Investorwords.com puts it that "this is usually followed by a meltdown" is cause for concern but last week's hammering certainly gives one pause to think.

The bottom line is no one, no matter who it is, can predict market direction, no way, no how.

The nature of markets

Obviously markets rise and fall as a matter of fact and historically speaking, but who's to say this market can't quadruple again before correcting, if it corrects at all, or if we see a continuing erosion in the indexes causing many an investor to hit the sell button.

Most analysts and investor alike would likely concur market falls are an expected event but when and by how much they fall is an unknown fact to all. Corrections are viewed by some as a healthy and normal pattern of markets in general.

The fact remains although manias, boom, bust cycles and "irrational exuberance" as Fed Chief Alan Greenspan once quipped in response to the dot com run up, may appear as excessive to some, but markets don't follow scrips nor give a hoot about what anybody thinks might happen.

I have always said markets will reflect reality eventually but their day to day movements are only the perception of all the millions of investors in it on any given day. That said, the term melt up is only that: a term made up by some to describe what they perceive as an irrational movement over a given time period.

As in all debates however, there are others on the opposite side of the analytic spectrum that say the drastic movements in the markets are only a sign of a healthy and booming economy. Although the rise in the market over the past 14 months has indeed been remarkable, there is no absolute law of markets that say it can't continue up or that it must continue to fall such as we witnessed in recent weeks.

As in all things however, and as the Boy Scouts say, hope for the best but prepare for the worst. That way, no matter what happens, at least you have a chance at not becoming another in a long line of investors who just hoped for the best, and did nothing else.

This is not a solicitation nor recommendation to buy or sell any securities. Investing involves risk and you can lose money. Consult a qualified financial advisor before making any decisions and do your own research before investing. This article expresses the opinions of Marc Cuniberti and are opinions only and should not be construed or acted upon as individual investment advice. He is an Investment Advisor Representative through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. He can be contacted at 530-559-1214, or SMC Wealth Management, 164 Maple St #1, Auburn. SMC and Cambridge are not affiliated. His website is http://www.moneymanagementradio.com.