Barclays issued an alert this week: the market could experience a “melt up” in the near term if a few things materialize, including a truce in the trade war between the U.S. and China, the Fed cutting its benchmark rate, and the economic slowdown turning out to be just a “soft patch.”
A “melt up” would be marked by a sharp move higher driven by investors’ FOMO on a momentum push, and has historically signaled an end in late-stage bull markets.
Such a “melt up,” according to a note from Barclay’s head of equity derivatives strategy, Maneesh Deshpande, “is indeed possible, but would require a confluence of several outcomes: 1) Trade tensions decrease substantially; 2) The Fed eases aggressively; 3) The current industrial slowdown remains a soft patch and does not morph into a full recession.”
“Although this is not our most probable scenario, we acknowledge that its likelihood has increased,” Despande wrote.
The S&P 500 hit a record high last week and has had its best first half to a year since at least 1997 as the market has cheered the Fed’s dovish turn and has placed a 100% chance bet on a quarter-point rate cut in July.
According to Barclays, softened policy from the Fed in past economic slowdowns has historically spurred “substantial valuation-driven equity rallies,” and a similar move this year could send the S&P’s price-to-earnings ratio to 20 times, sending the index to 3,250, or nearly 12% higher from Wednesday’s close.
“There are now signs that the Fed will remain aggressive irrespective of trade tensions, which is likely to be viewed by equity investors as the Fed erring on the side of being ultra loose,” Deshpande said.
As for the trade war, a truce between the U.S. and China could send the market surging higher.
“While we cannot rule out a detente, we and the markets remain skeptical of a meaningful change at the G20 meetings,” Deshpande wrote. “A substantial truce which gets extended as U.S. election nears” is precisely what the market needs to climb higher, he noted.
But a “melt up” could be a bad sign for what’s to come. And according to billionaire investor Leon Cooperman, a big move higher in stocks could signal “the close-out move” for this bull market.
And not only that, but Barclays warns that the earnings slowdown could shift from a “soft patch” into a full-on recession.
If “the current industrial recession bleeds into the broader economy and even if Fed eases, they cannot stave off an equity selloff of about 20%,” Deshpande wrote.