Guest Post: The Spirits Are About To Speak. Are They Friendly?

Tyler Durden's picture

Submitted by Contrary Investor. A highly recommended read.

The Spirits Are About To Speak. Are They Friendly?...And of course we are referring to “animal spirits” as you might have guessed. Time for a little compare and contrast with current cycle margin debt trends relative to past meaningful cycle equity lift off periods. You may remember that in the past we have looked at margin debt at stock cycle inflection points very much being a corroborative indicator at the birth of many a historical equity bull market. History tells us that margin debt balances bottom literally within a month or so of past major market low points. And sure enough, we saw margin debt bottom for the current cycle (so far) in February of this year – right on schedule! So, yes, at least at this point, a bottom in margin debt balances confirmed the bottom in equities. The chart below will give you a feel for exactly what we are talking about in terms of this directional synchronicity between equity market and margin debt rhythm.

Ok, trying to corroborate equity market bottoms by watching the rhythm of margin debt is fine. But what happens next? By that we mean what has been the character of margin debt growth as equity markets have continued on their historical bull market journeys? We’ve put a table of numbers together below to help give us some perspective. You know the financial media simply cannot stop trumpeting the fact that equities in general are up 40%+ from the March lows of this year. Just the kind of media taunting to make folks feel as if they are idiots for having potentially missed it. Of course the headline financial media has absolutely no recollection at all that they had been screaming buy all the way down while the equity markets dropped over 50% in the first place. Selective memory works every time, right? Anyway, to compare and contrast current circumstances to prior cycles, we went back and looked at the first 40% move of each major post recession equity bull market since the early 1970’s. We looked at just how much margin debt had already increased by the time the S&P had risen 40% from cycle lows. Have a look.

Notice anything funny? Of course you do. The current cycle is a complete anomaly relative to past experience. Margin debt balances (current info through June) have increased 8.6% from the lows. But you can see the strength of margin debt growth in prior cycles. Off the charts is the only characterization that fits when comparing this experience to the present. Who knows, maybe margin debt is about to grow parabolically for all we know. But for now what this says is that this market move is not being accompanied by animal spirits, if you will. Leverage is not the name of the game, as has been the case in past cycles. We already know this has been a very low volume rally considering the move from the bottom to the present. What this also says to us is that government/taxpayer funds jammed into the financial sector that is not being lent out is a big part of the bull market puzzle here. This unprecedented stimulus has to find a home. We saw exactly the same thing when Greenspan flooded the system in late 1998 and 1999 pre-Y2K. The NASDAQ doubled, and then summarily collapsed. The character of margin debt is suggesting to us that the levered public is not a big driver of what is happening here. It’s the momentum players, the “liquefied” bank (think Goldman, Morgan, JPM, C, BAC, etc.) prop desks, etc. that are the major drivers here. The very epitome of long term investors, right?

The following chart shows us the year over year change in NYSE margin debt outstanding. As of June, the current number is still near a 40% year over year decline. We’ve drawn in black lines as to where this number has gone positive in all prior cycles. As we see it, growth in margin debt really started to be a major support to market prices when this both swung into positive territory and kept right on growing in almost vertical fashion, as has been a character hallmark of all prior post recession cycles.

So, the question becomes, when will the true “animal spirits” on Wall Street reveal themselves? It has not happened yet. And that says liquidity and momentum support for the markets is narrow and potentially volatile. Squeezing shorts and running technical stops can work well for a while. But what happens next if animal spirits broadly are not fully engaged? For now, margin debt is telling us animal spirits are very subdued. Very subdued.

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SWRichmond's picture

Kill moose and squirrel.

SWRichmond's picture

Do you not remember Rocky and Bullwinkle?

"The spirit's are about to speak!"


Sqworl's picture

Remember, r u kidding...Im Natasha!

eggy123's picture

HA! Natasha was a hottie.

srkast's picture
srkast (not verified) eggy123 Aug 24, 2009 9:38 AM

the real unknown is who is really holding the hand. It is clear that the is no

matthylland's picture

Great article. I love analysis like this.

Whoever thinks this economy is sustainable is delusional to say the least. The only problem is it makes me look crazy saying that as the market rallies 40%...


When we are right and this all comes to an end...will we just be another 'broken clock' that everyone talks about?

Anonymous's picture

I think you might be a little optimistic if you think that this will all "come to an end" soon. We have seen types of behaviors like this in smaller nations. The end result is typically the same, which is that you rapidly create a split between the rich and the rest of us, and create huge geopolitical instabilities in the process..

Every time the FED does a liquidity push, they further enrich a small minority while leaving the rest of us poorer. In time this will create one of two scenarios, but both will revolve around private debt levels. One is mass walk away from financial obligations, which will slowly grind away our financial systems viability. The second is a political shift of winds that favors the average citizen. Many thought that Obama was this shift, but it is obvious now that he was a decoy... Either way, one or the other will occur and the system will eventually balance. I assure you, however, that it will be very slow coming....

Project Mayhem's picture

My personal view is that much of this 'rally' has been influenced by corruption -- for purposes that are not yet clear.  Take simply two points


1) Most all the volume was through five financial stocks.  See Tyler's article yesterday.


2) The Federal Reserve has been using equity derivatives (among others) on its balance sheet-- expanding the total from zero to $1.3trillion (approx) since March 2009.  See Tyler's article two days ago.


Cindy_Dies_In_The_End's picture

I think its VERY clear, "they" let it go, then it all falls down.


PPT is out in full force.

Anonymous's picture

Yeah, well I think its very clear that there's one hell of a double top in that chart.

"They" can try to keep it going but the rest of the street is looking at that chart and getting very, very nervous.

Sqworl's picture

PM: I concur, but unfortunately unless a major foreign exchange has a meltdown.  The fraud will continue by Vampire Squid and we are the victims.  Do not expect, our government to even consider nor *think* about doing anything to stop the game.  With Arthur Levitt now lobbying on behalf of Banksters...

Geithner is nobody's Patsy...It's Bernanke who will be made the scapegoat in history.  The present SEC chief is a deciple of Levitt.

Chumly's picture

Interesting point and it may be happening.  If you overlay the EUR/JPY on the major indices, there is now very clear divergence since the middle of last month.  The EUR/JPY is not the "be all to end all" as a leading indicators but it is remarkable and support is losing strength...the 132.50-134.50 range is this pair's last hope to hang on, then look out below.

Printfaster's picture

Here is why.  HFT is a manifestation of Fed policy.

We are faced with a short squeeze in dollars which becomes manifest in HFT.  HFT is an attempt to speed velocity to compensate for the collapse of monetary supply due to the collapse of credit and the Fed's policy of not issuing enough dollars to cover the maturation of treasury credit.

Here is the problem.  When treasury issues credit it sucks a dollar out of circulation and pays it out to a payee and issues a credit in the form of bill, note or bond.  When that credit comes due, it has to suck a dollar out of the economy using taxes.  For example if all T debt were due at once, there is currently not enough money in circulation to pay it out, since the money that it paid out was money in flight.

HFT is a wild attempt to increase velocity to hold up the economy while money supply is collapsing due to the collapse of credit.  As soon as velocity slows down, everyone defaults.

The reason that the stock market is going up, is that it now cannot go down.  If the market goes down, it will trigger massive sales which will require liquidity which does not exist.  That lack of liquidity will trigger massive liquidation which because of the lack of money supply will cascade into catastrophe.  First stocks are sold, then short treasuries, then company debt, then longer term treasuries, then foreign currency, then foreign stocks, then foreign debt, then everything.

eggy123's picture

Yes, it can go down, and it will. This cannot continue for much longer. The question is when. Another  5 days or another 5 years??

Hephasteus's picture

Good time to switch currencies. A completely fiat currency based on population under congressional control.

Anonymous's picture

This would gibe with how violently the market bounced off 870 and 980 on the second attempts each at falling below those levels (on July 13th and August 19th, respectively). It was as if someone or something was terrified of what might happen should the market fall below those levels. Moreover, the distance that the market put between itself and those levels in very short spans of time suggest that those in control don't want to revisit those levels anytime soon.

Hephasteus's picture

Still doesn't matter. Chinese have only dumped 1/2 trillion dollars worth of holdings and it's nuking down the dollar terribly. They'll eventually give up and just take what they can get and go home. The market is just spoiled. They'll do same thing they did in great depression. Make it look like it's over and keep it going and going and going till replace all the money lost to toxic loans. It would just be so much easier buy those bond with a new currency and let it rot or slowpay or just sit playing with itself. ALL THESE bond sales are saying that to pay what we owe now we are going to have to live without money for 5 to 10 years while the dollars that they got from those bond sales get funneled into GOD knows what sorts of activities.

I just don't think it's going to turn out well watching 1/2 our money supply get hijacked by people who won't tell us anything about what is going on and expect us to live with a crap economy nearly forever.

Assetman's picture

Wow, now THAT was a rally good post!


Anonymous's picture

Printfaster, how do you see it ending?

Printfaster's picture

The US will institute tariffs.

What people forget it is not the current accounts that need to be balanced, it is the trade deficit that needs to be balanced.  Currently we are fooled by CAD dropping where the trade needs to be fixed.

The only way out is tariffs or we trash the dollar and hyperinflate.


Chumly's picture

Nothing has changed since August 2007, just the rules of a rigged game to allow more late hits, piling on, etc,.  The illiquidity-insolvency of the world financial system is alive and well and the next move down will be more shocking, even for us who expect it.

TumblingDice's picture

Kid, you're on a roll. Enjoy it while it lasts, 'cause it never does.

Anonymous's picture

Timing is everything.........I would rather have the assist when it is needed most than when I am fully stocked and provisioned!

Anonymous's picture

"Squeezing shorts and running technical stops can work well for a while."

I think it's the heavy hand of the junior B-team, not skilled enough to hide the objectives from the sheeple. Perhaps stealth, and spirits, will return at the end of the Hamptons season.

Anonymous's picture

During uhhuhm the "Great Depression" of the 30's big bankers and "Icons" tried to step in front of all the selling occurring to bring "confidence" to the market.

deadhead's picture

excellent piece.  another great perspective that I did not even think of.

thanks ZH

Anonymous's picture

This market 'rally' has never felt right to me. I could never articulate why. This analysis plus Tyler's about the fab five stocks accounting for the volume has started putting things into perspective.

Does the traditional media not know or not care or is it something else entirely? Until now, 'something else entirely' was never plausible in my little world.

Anonymous's picture

Wait, doesn't this suggest the bulls have a lot more dry powder? A frightening amount of dry powder....

Anonymous's picture

Wait, doesn't this suggest the bulls have a lot more dry powder? A frightening amount of dry powder...

Sqworl's picture

The dry powder on the sidelines will never be used again!  Its a fucking myth used by the Shrills at CNBC.


D.O.D.'s picture

Yes, and I think if you're a true bull, you bet the farm here and charge it to the card, I, for one, am, this baby is goin' higher...

srkast's picture
srkast (not verified) Aug 24, 2009 9:38 AM

excellent case that under the circumstances
that seasonal adjustment is misplaced given the
nature of the data series....

Anonymous's picture

Isn't the fact that this bull run is NOT based on margin a positive?

Anonymous's picture

The Fed is the margin!

Anonymous's picture

Subdued animal spirits could be bullish as much as bearish. Unused margin buying power adds to the wall of dry powder on the sidelines.

Anonymous's picture

Great research and work.Of course,currently the fed is subbing for that lost margin. And no I don't believe the fed gonna let it all go to waste by suddenly pulling the plug, as that might draw a backlash and bring attention back on the tbtf. I think those who took the ride down might decide to liquidate their retirements funds once they are close or at breakeven, after they realize that after all those years they are neither better nor worse,so why get an ulcer for practically no reward?they might as well take their money and payoff their mortgage and credit card debt,which will give them a better return on their money.

Anonymous's picture

A log scale on those charts would be nice

Anonymous's picture

Can you say "Double Top"?

spekulatn's picture

Well done TD. Thanks for sharing CI's stuff.



madmax's picture

This might just indicate that the double and triple leveraged etf's are being utilized instead of margins. 

Steak's picture

Shiit, dabble in some options and you get all the leverage you could want.  I concur that there are many ways to make big bets with little capital that don't involve hitting up your broker for extra chips.  Though it does feel as if a shudder is about to go through financial markets.