The Real Source of the “Melt-up?”

The Dow broached 24,000 on Nov. 14.

It crested 25,000 on Jan. 4.

Today… only 12 days later… the Dow briefly crossed 26,000.

Is the “melt-up” truly at hand?

If so, who — or what — is behind it?

And how long can it last?

Today we reveal startling new information… information our agents have only now brought to our awareness.

But first a brief review…

The “melt-up” phase is that period of delirious, incandescent glory stocks enjoy… before melting down.

It is the all-consuming flame that burns brightest before its death.

Last week we wondered how stocks could “melt up” while the Federal Reserve is raising interest rates and reducing its balance sheet — that is, while reducing the flammable liquids feeding the flame.

We suggested it was because the Federal Reserve has scarcely reduced its balance sheet at all, despite its rhetoric.

And that the European Central Bank (ECB) still has the kerosene flowing — though perhaps at a diminished rate.

But can these factors alone explain the melt-up?

Our agents inform us that investigators at Citigroup have unearthed new evidence…

These investigators have discovered that any liquidity reductions to date have been vastly offset by large liquidity additions from elsewhere.

But where?

Emerging markets… led by China.

Zero Hedge:

According to Citi’s analysts… although both the Fed and ECB are scaling back their balance sheets, the increase in emerging markets’ foreign exchange (FX) reserves recently, with Chinese FX reserves doing the majority of the heavy lifting, has largely offset all of this… on a rolling three-month basis, FX reserve purchases by EMs have largely offset all of the implied downward risk from the past year.

Zero Hedge reminds us that last week China reported its foreign exchange reserves recorded their 11th consecutive monthly increase.

In December, Chinese reserves increased $20.7 billion alone… and totaled $129 billion for the year.

“Against that background,” affirm Citi’s arson investigators, “it is no surprise that equity markets have been so well supported…”

Indeed… it is no surprise.

Or, in fairness, would be no surprise.

To connect the dots… and to test the Chinese liquidity theory… let us further rewind the spool of events…

Perhaps you recall the “Shanghai Accord”?

In February 2016, the world’s central bankers hied themselves to the fair city of Shanghai.

Convert Shanghai to a verb… and the destination becomes oddly fitting.

Their purpose, says Jim Rickards, was to weaken the Chinese yuan without appearing to do so…

The previous two occasions when China devalued (August 2015 and January 2016), the U.S. stock market took violent staggers.

And to hazard a third?

The solution, says Jim, was a stealth devaluation…

The dollar would weaken under the Shanghai Accord.

And since it is pegged (softly) to the dollar, so would the yuan:

[The Shanghai Accord] was a way for China to cheapen their currency without breaking the peg to the dollar. You would cheapen the dollar, and then China would keep the peg, and the Chinese yuan would cheapen along with it.

The Chinese central bank subsequently unleashed a torrent of liquidity into the market.

And since the Shanghai Accord of February 2016… the S&P has finished in the green a record 21 of 22 months.

It will likely end January 22 of 23 months in the green.


We defer to your good judgment.

And more to the point… is China’s foreign exchange buying spree of 2017 the hidden source of the melt-up presently in evidence?

Citigroup investigators think they have their suspect.

So does Zero Hedge:

It again appears to be China’s stealthy asset purchases across global capital markets that has resulted in the market melt-up observed in the end of 2017 and start of 2018.

But if true… it would only explain the “melt-up” to date.

What about next week… next month… next year?

Recall the Fed has begun to withdraw stimulus, however haltingly.

And the ECB has pledged to begin this year.

So this question:

Will (mainly) Chinese liquidity infusions continue outpacing projected balance sheet reductions by the Fed and ECB?

Apparently not.


Even if emerging-market FX reserves were to continue accumulating at close to their current rate, that would be outweighed by the almost $1 trillion reduction in developed market (DM) central bank balance purchases due to occur this year.

History says the “melt-up” can last six months to two years.

But if Citigroup’s theory has juice, two years may be… optimistic.

We do not know when the “melt-up” melts down, of course.

But we do know it’s better to get out one month too early… than one minute too late…


Brian Maher
Managing editor, The Daily Reckoning

The Daily Reckoning