All-time highs? Yeah, we've got those.
- In early March the
Dow Jones Industrial Average
(INDEXDJX:.DJI) finally snapped its early October 2007 high at
14164, and despite some subsequent choppiness, that level has
(INDEXSP:.INX) quickly followed suit, banishing its own October
2007 high at 1564 to the statistical dustbin in late March.
(INDEXRUSSELL:RUT) actually accomplished this feat in April 2011
- if only by a few points before failing to push higher - and
then anticipated its large cap peers by doing it again in January
- As for the
(INDEXNASDAQ:.IXIC)…well, let's just say its made a good start
retracing back to its March 2000 high at 5132. In fact, January
marked the first time the index closed above the 50% retracement
of the dot-com crash, just above 3100.
Now another measure is on the edge of printing a fresh record, one
that's intimately correlated to the resolve with which these
indices are pushing into uncharted territory: margin debt.
What Is It?
Toward the end of each calendar month, the New York Stock Exchange
releases data on the total amount of debt carried (or "Securities
Market Credit" extended) in all margin accounts at NYSE member
organizations for the preceding month. Put simply: This is the
total amount of money across all NYSE members
by their customers to purchase securities. "Members," by the way,
are firms you've no doubt heard of (Fidelity,
(EPA:BNP)) and maybe some you haven't (Battenkill Capital,
Why Is It Significant?
Principally, margin debt is a sentiment measure. What metric could
be a more direct indicator of how market participants are feeling
than their demonstrated willingness to borrow money to buy stocks?
The amount of debt racked up in margin accounts offers a sparingly
terse, effective answer to that. This isn't a sentiment poll
reliant on the mood, memory, and other subjective foibles of its
respondents, but a roughly comprehensive and purely quantitative,
earnest-money measure of confidence.
Similarly, margin debt equals
borrowing capital to buy stocks carries a heightened capacity for
reward (keep all the profits generated by the money you borrowed!)
and risk (or apply a multiplier to how much you're otherwise
losing). In other words, margin debt is significant because it
spells out how much real money real managers of capital are willing
to lay on the line, and how much they've raised the stakes on
(hopefully calculated) bets they're taking.
With that brief primer out of the way, here are the NYSE margin
debt figures for March published at the end of last week (the
number we've been discussing is in the left-most column):
In March, margin debt clocked in at just shy of $380 billion. As
for the other sometimes overlooked, but vitally important values in
this table, they represent 1) the cash lying idle in non-margin
("cash") accounts and 2) the credit (as opposed to the debt we've
been talking about) on hand in margin accounts. We'll look at this
more in a moment, but for now, the left column is a negative; the
middle and right columns are a positive
Put it all together and you have a concise picture of the aggregate
market's net worth.
If $380 billion sounds like a lot of money on the line, that's
because it is. In fact, in nominal terms, March 2013 is the highest
margin debt figure on record, second only to July 2007. That year,
margin debt peaked three months before stocks did. Since we're on
the topic of all-time highs, here's that year in full:
Comparing March 2013 to July 2007, you can see a nominal record
high in margin debt is a small step away.
Comparing these values and dates evokes mild alarm and some
pressing questions: Is margin debt a leading indicator of major
market turning points? Is this $350 billion-plus a kind of
"irrational exuberance" line in the sand where the animal spirits
that have been driving margin borrowing up and stock indices higher
begin to cannibalize themselves and ultimately subvert the bull
market they've created? What's to prevent margin debt from rising
higher? And does attainment of record levels have to mean a violent
downturn, or we see margin debt moderate over time unaccompanied by
a major bear market? Is margin debt telling investors to expect
something like late 2007 (and after) in the near-term?
As a partial answer, there is an indisputable positive correlation
between the growth and contraction of margin debt and broad-based
market performance. As you might expect, the value of stocks held
and the amount borrowed to hold them necessarily goes up and down
as the market does. But whether margin debt's rate of growth and/or
absolute level has a causal link to market tops and bottoms is more
controversial and difficult to demonstrate.
The goal here is more modest: to review what margin debt is and see
if it has any pressing relevance today.
As I mentioned earlier, the middle and right columns in the graphs
above are very helpful for providing context and "anchoring" margin
debt so we can speak about whether the current level of borrowing
is modest, moderate, or excessive.
So where are we?
Again, March 2013′s figures show "the market" as a whole is in the
hole some $380 billion. Over on the positive side of the ledger
(middle/right columns above), cash and credit come to $287.3
billion. The result: the market has a
net worth of -$92.2 billion.
Looking beyond raw margin debt, this net worth figure far exceeds
the June 2007 high of -79 billion. However, it isn't a record. As
the following chart
published in March
(pulling from January 2013′s figures) by Doug Short shows, at its
height the dot-com bubble featured aggregate negative net worth
exceeding -$100 billion for multiple months
So it's not a record. But keep in mind: Early 2000's aggregate net
worth figures are what drove the Nasdaq to 5132, a speculative peak
from to which it is only beginning to appreciably recover 13 years
later. Perhaps 2007′s net worth figures are more instructive, but
if so, that lends little comfort. Negative net money doesn't
necessarily indicate a market top, but negative net money blow-offs
(February 2000, June 2007, even spring 2011) do appear to precede
market tops. Are we witnessing just such an occurrence right now?
With the impact of inflation, market cap growth, and the
not-so-invisible hand of the Fed, the picture has never been
muddier. Let's just say the "excessive" conditions that prevailed
in pre-QE world are here once again. The environment is different,
but history may rhyme, despite those forces arrayed against that
The key to understanding this is the concept of "adversity
tolerance," i.e. the degree of stress the aggregate market's
balance sheet can take. If history is any guide, according to
aggregate margin debt and net worth right now, "the market" is
confident - highly confident. But like any bout of confidence and
bull market built on rising levels of debt, the instrument of the
market's growing confidence ironically sows the seeds of its own
If stock indices do take a sizable turn south, judged in historical
terms the depth of the market's negative net worth means it has
very little tolerance for that kind of adversity. In practical
terms, this means there's little margin for error (read: selling);
and little room to maneuver before margin calls occur and forced
selling is required. This activity creates a downdraft that can
spin a healthy pullback into a more significant correction, if not
a protracted bear market. In fact, the amount of margin debt taken
on ahead of these downturns demonstrates a behavioral pattern where
the aggregate market is either entirely oblivious to what lay ahead
or radically underestimates the depth and extent of the adverse
move it will have to weather.
Market timing with sentiment measures is a very difficult business,
but as a contrarian read on the environment, polls and stats like
margin debt and net worth can be invaluable inputs to a process
that makes more quantitative assessments of risk. Right now, the
confidence reflected in that input - its own
emerging bubble in certainty
- counsels heightened caution.
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