Understanding Melt-Ups: Causes, Mechanisms, and Real-World Examples

What Is a Melt-Up?

A melt-up is 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 economic improvements.

Gains that a melt-up creates are considered to be unreliable indications of the direction the market is ultimately headed and often precede downturns known as meltdowns. Investors should pay attention to economic indicators and company fundamentals to avoid poor decisions during these periods.

Analyzing Melt-Ups with Economic Indicators

Ignoring melt-ups and meltdowns and instead focusing on fundamental factors begins with an understanding of economic indicators. Economic indicators come in the forms of leading indicators and lagging indicators. These are all forms of economic indicators, which investors follow to forecast the direction of the stock market and overall health of the U.S. economy.

Leading indicators are factors that will shift before the economy starts to follow a particular pattern. For example, the Consumer Confidence Index (CCI) is a leading indicator that reflects consumer perceptions and attitudes. Are they spending freely? Do they feel like they have less cash to work with? A rise or fall of this index is a strong indication of the future level of consumer spending, which accounts for 70% of the economy.

Additional leading indicators include the Durable Goods Report (DGR), developed from a monthly survey of heavy manufacturers, and the Purchasing Managers Index (PMI), another survey-based indicator that economists watch to predict gross domestic product (GDP) growth.

Lagging indicators change after the economy adopts a pattern. They often follow the price movements of their underlying assets. Certain examples of lagging indicators are a moving average crossover and a series of bond defaults.

How Fundamental Investing Can Help Avoid Melt-Ups

Many investors attempt to avoid melt-ups and their impact on investor emotions when placing bets by instead focusing on the fundamentals of companies. Warren Buffett, for example, is a famous value investor, who made his fortune by careful attention to companies’ financial statements, even amid economic turmoil. He focused on corporate value and price: Was the company on solid financial footing? How experienced and reliable was the management? And was it overpriced or underpriced? These questions often help investors focus on intrinsic value over hype.

Historical Examples of Market Melt-Ups

Financial analysts saw the run-up in the stock market in early 2010 as a possible melt-up, because unemployment rates continued to be high, both residential and commercial real estate values continued to suffer, and retail investors continued to take money out of stocks.

During the Great Depression, the stock market experienced several melt-ups, even as the economy was weak. Stocks dropped over 80% from 1929 to 1932 but gained more than 90% in July and August 1932, continuing to rise for six more months

The Bottom Line

A melt-up is a rapid, often unsustainable surge in asset prices driven by investor herding rather than solid economic fundamentals, and it frequently precedes market corrections or meltdowns. Investors should focus on key economic indicators and company fundamentals, like financial health and management quality to avoid hype-driven mistakes.

Historical examples, such as market behaviors in 2010 and the Great Depression, show the risks of melt-ups, underscoring the need for informed, fundamentals-based decisions.