The U.S. economy is coping with alarmingly high double-digit unemployment, a widening commercial real estate bust, and over-indebted consumers. Few think the economic recovery now under way will be a spectacular one in 2010. So why has the stock market surprised skeptics by powering higher in recent weeks? One explanation being bandied about by equity strategists and portfolio managers is that the stock market may be in the midst of a momentum-driven trading phenomenon known as a "melt up" that has precious little to do with economic fundamentals.
A melt up is a rapid and mass rush by investors into an asset class after a belated realization by market players that worthwhile gains are to be had there. Part herd mentality, part self-fulfilling prophecy, this trading behavior is amplified by the age-old tendency of fund managers and retail investors to chase returns in the hopes of making up for lost time and lagging performance. The U.S. stock market is enjoying an explosive rally that has humbled plenty of bears, who have been predicting a deep correction for several months now. Instead, the Standard & Poor's 500-stock index has soared 63% since its Mar. 9 low and is up 22% for 2009.
That has left plenty of money pros rethinking their market outlook. "We've spent a considerable time of late assessing the conditions for a melt up," admits Bernie Schaeffer, chief executive of Schaeffer's Investment Research. He says he is baffled at how the market's rally this year has essentially been devoid of improved investor sentiment and big inflows into domestic equity funds. While bond funds have taken in nearly $330 billion so far this year, U.S. stock funds have lost almost $28 billion. A handful of big institutional investors and hedge funds, rather than retail investors, have been responsible for the lion's share of buying this year.
In fact, overall there is far greater investor enthusiasm for asset classes other than U.S. equities. Emerging markets, which have outperformed their American counterpart, are being deluged with fresh money. The red-hot junk bond market is also attracting heavy investor interest. Even gold coins are being hoarded as the yellow metal keeps breaking records.
Mom-and-pop investors in U.S. stocks, meanwhile, are only slightly less bearish than they were in March, when the market hit a 12½-year low. Yet that could change, given the impressive performance this year in the S&P 500 and Nasdaq Composite Index (NDAQ), up about 38% in 2009. "If 2010 starts out strong as well," says Schaeffer, "the fear of missing out on stock returns could prove irresistible." Not coincidentally, January happens to be high season for personal finance introspection—with outsized attention paid to the past year's performance column and the coming year's retirement account funding.
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