Inquiring Minds: Is Our Economy Headed for a Meltdown?

I’m a worry-wart…always fretting about the next market correction. Most folks are familiar with “meltdowns”. But what about a “melt-up”? And is our economy in a melt-up heading for a dreaded meltdown? NOTE: Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.

Most Bizarre Recession

Just last year, we experienced the worst - and most bizarre - recession since the Great Depression. It was bizarre because the 2020 decline occurred in just four months - and only about two months in the U.S. - instead of the four-year Great Depression.

After a general slowdown in 2019, the COVID-19 pandemic dealt the economy a powerful blow after millions of businesses closed temporarily and there was a huge drop in economic activity. In April 2020, the U.S. economy lost 20.6 million jobs. Remarkably, things started rebounding the very next month - May 2020 - after the White House approved the first of several massive relief packages for individuals and businesses. It worked.

What is a Melt-Up?

Since that time, the S&P 500 has been experiencing explosive growth, the very definition of a melt-up. Now, here we are in late August 2021, watching the S&P 500 achieve its 50th all-time high of the year! Good grief! And...the second most “through August” performance in 70 years.

Now the looming question is: Are we in one of those melt-ups - right now? One thing is certain. We’re living in extraordinary times. Home prices are through the roof, as are car rentals and used car prices. Inflation is also creeping onto our grocery shelves and into our gas tanks, but many of these things are largely due to pandemic-related supply chain problems.

Still, I remember the mid-to-late 1990s "Dot.Com Bubble" that peaked in 2001 (a 266% S&P 500 gain, assuming reinvested dividends) and then went to hell in a handbasket…a gut-wrenching almost 50% decline over the next three years. Quite a change from those heady 1990 years when the S&P 500 experienced only three corrections of barely 10% or more. Now that’s a true melt-up for you – a major, multi-year rally…followed by a big meltdown.

Meltdown Ahead?

Data suggests that the current S&P 500 market surge (call it what you will) on a comparative basis isn’t as bad (or should we say good) as it seems. Going back to an April 2020 pre-Covid moment, the S&P 500 is up about 40%, assuming reinvested dividends. That's quite a lot, but this approximately 18-month return is only in the top 14% of all 18-month returns since 1920, according to Nick Maggiulli's Of Dollars and Data. And over the last five years the S&P is up a heady 123% (assuming reinvested dividends), a gain that only ranks in the top 13% of all five-year periods since 1920.

In short, recent S&P 500 returns are high, but comparatively speaking, not nearly at record highs. Not even approaching the prodigious 266% DotCom levels. The optimists among us might even conclude that we are just at the beginning of a melt-up. I’m not a member of that glass-half-full crowd, but I suppose it could mean that the good times might last longer and get even zanier than they now seem…zany at least to this old dog.

Get Invested

Those of you who follow this blog know that I’m not one to sit on cash (except for Rainy Day funds to meet emergencies). I believe that it’s very important to be invested – and investing – in the market at all times (i.e., dollar-cost averaging those dividends and capital gains as they filter in).

Can you imagine sitting out the 1995-2001 DotCom bubble? Ah, the anguish! Without question, some of the gains would have disappeared in 2001-2003, but not nearly all of them. And by buying those ever-cheaper units along the way, your recovery time would have been enhanced.

Being invested through thick and thin is not irrational behavior, folks, but if that’s not your style, then by all means risk-reduce your investment portfolio. If in your opinion, a hot (melt-up) market is increasing your riskier holdings, consider rebalancing more frequently into more conservative possessions. Granted, this borders on trying to time the market – which I don’t encourage – but if it makes you more comfortable, go for it. Just stay invested in something!

In a hot market, not everything is spiraling up. In your effort to de-risk, you may wish to buy more bonds, but in an inflationary cycle, which the U.S. economy may (or may not) now be experiencing, you run that other risk imposed by Izzy The Inflation Monster: Buying-power erosion. Perhaps more non-traditional assets like real estate or a few works of art might be in order, but keep in mind the risks associated with illiquidity. More and more folks are venturing into cryptocurrency, but that’s still too gamey for me.

In Sum

Whatever you choose to do - don’t bail out or attempt to play the corrections that frequently occur in both melt-up or meltdown markets. It’s very difficult to know when to get back in without incurring opportunity costs…that timing problem again.

Just remember those PDQ Principles. Have faith in your quality investments, remain diversified, and exercise the patience required to survive the inevitable meltdown.