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What is a "Melt Up?"

As we begin this market commentary, I want to thank all our readers for taking the time and interest to follow our market commentary. Our team at Canterbury would like to wish you and your families a Merry Christmas and Happy Holiday season.

Canterbury’s recent Investor Insight articles have focused on two points regarding the extended nature of the markets. Both of these points remain relevant and are bulleted out below.

1.     Most major market indexes are “overbought” meaning that they have come too far, too fast. More than 40% of the S&P 500’s individual stocks are currently “overbought.” This has only occurred 4 times since 1970.

2.     There is very low Bearish sentiment among investors. Only 19% of those surveyed indicated that they were bearish on the markets right now, according to the AAII Investor Sentiment Survey. Market sentiment is a contrarian indicator, meaning that markets will typically do the opposite of what the herd is expecting.

We can’t predict the future, but we remain in a high-risk market environment. The indicators point to the markets being overextended and due for either a pullback or correction. When markets become extended, they tend to pullback or correct to relieve overbought conditions. Again, keep in mind that there is no predicting the timing or extent of when those will happen.

In other news, the Federal Reserve spoke last week and indicated that they will cut rates in 2024. This news created some market “noise” and further fueled investor optimism. Whether or not reality will meet that level of optimism remains to be seen.

Just as observation, the market’s short-term advance is a characteristic of a “melt up,” which Investopedia defines as “a sustained and often unexpected improvement in the investment performance of an asset or asset class, driven partly by a stampede of investors who don't want to miss out on its rise, rather than by fundamental improvements in the economy. Gains that a melt-up creates are considered to be unreliable indications of the direction the market is ultimately headed. Melt ups often precede meltdowns.”

Simply put, stocks are going up because investors are buying, and investors are buying because stocks are going up. December is typically an optimistic month and one where money managers will “window dress” their portfolios to appear fully invested. It will be interesting to see what happens at the beginning of the calendar year.

One economist that our team knows and respects is Robert Barone, who writes for Forbes each week. In his recent articles, While Bob points out that certain factors such as inflation data continue to improve, he also points to a few negative developments in the economy. Here are some quotes from Bob’s December 9th article, titled “Despite ‘Strong’ Jobs Report, Recession Still Locked In”:

·        “The employment report will eventually turn out to be a ‘head fake.’ “We find no corroborating evidence that the labor market is ‘strong;’ in fact, just the opposite.”

·        “The holiday retail season looks to be a dud. The retail industry didn’t hire as usual, and who knows the outlook better than the retail executives themselves?”

·        “China’s economy is clearly in Recession with talk now of possible defaults of local government bonds. Such events will have significant impacts on that economy, as many Chinese consumers hold such paper.”

·        “Our forecast continues to be that a Recession has either already begun or is imminent.”

Source: Robert Barone (with contributions from Josh Barone and Eugene Hoover), “Despite ‘Strong’ Jobs Report, Recession Still Locked In” (Dec 9,2023). Published on Forbes.

Portfolio Management Comment

Just two months ago, investors and were very pessimistic on the markets. The S&P 500 had fallen more than -10% and put in a series of lower highs and lower lows. Investor sentiment showed that 50% of investors were bearish. The equal weight index and Russell 2000 suffered even worse losses. Then, to begin November, markets began a straight shot up. The indexes and sectors that had experienced the worst declines also saw the best rallies.

In fact, all the money that has been made in the markets this year has come during January and in the last two months. January was a normal rally during a bear market. The last two months have been an unexpected parabolic rise. This type of move is not one you would expect to see during a bull market, nor is it one that you would expect to be sustainable.

In September and October, Canterbury’s portfolio allocation was relatively defensive. As a result, the portfolios experienced very limited volatility and fluctuation during a difficult period in the markets. As markets rallied in the last two months, the portfolio remained stable. Now, the markets are in a vulnerable position, having come too far, too fast. Rotating the allocations of the portfolio would leave it more vulnerable to a whipsaw.

That being said, the Portfolio Thermostat has been rotating some individual positions into stock securities over the past few months. To name a few positions, the portfolio has allocations to Costco, Aflac, Vertex Pharmaceuticals, Roper Technologies, and most recently Amazon.


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