How telling is the level of borrowing to finance stock trading? In the short term the answer seems to be ‘not hugely’ – though expanding levels of margin debt are generally held to be a bullish signal, as investors borrow to secure their share in expected market gains, while contracting levels of margin debt are held to reflect a fall in confidence.
This year for example, NYSE margin debt peaked in July at $381.4bn, before falling as the credit squeeze took hold, recording the two largest drops since 2003. The latest month of data though, for October, saw a rise of 4.8 per cent to $345bn.
But it is over a longer time period that such data is more revealing.
Barry Ritholtz at the Big Picture has written often about margin debt, once commenting:
During healthy bull markets, increases in margin debt is not a bad thing: It provides fuel for further market gains. Its only when debt reaches excessive speculative levels that it is potentially problematic.
In his latest post though, back in October, he noted that things were getting worrisome. The total amount of margin had been rising both absolutely, and as a percentage of total market cap. If the sell off accelerates, and investors start to face margin calls, things could get ugly, he warned.
ContraryInvestor.com is also concerned. In their latest Market Observations report for December they take an detailed look at the “other” credit market. Their first point is that historically margin debt has been a coincident, not a leading, indicator of a stock market peak.
The latest spike in margin debt has corresponded with a big run in equity markets from summer 2006 to summer 2007, they note. It looks unsustainable.
But it’s not just the nominal debt balances that are pointing to trouble. ContraryInvestor.com looks also at the year on year rate of change in NYSE margin debt.
That growth rate has only spiked over 60 per cent on five occasions in the last fifty years – and one of those, in January 1993, was thanks to a change in methodology made late in the previous year.
The latest two growth peaks are showing in the next chart, below right.
NYSE margin debt passed the 60 per cent year on year growth mark in December 1999, and peaked in March 2000.
In 2007, the rate of change level was breached in June. “The history of margin debt relative to equity market price movement over the last half-century is suggesting to us we’re at a high risk juncture right here,” says Contrary Investor.
Looking back through the corridors of history, the report adds that, excluding the anomalous 1993 spike, the S&P finished both nine and 12 months lower after all of the three other 60 per cent plus occurrences.
We’re living peak number five. The NYSE’s margin data seems to hold a warning from multiple viewpoints.