The Last Two Times This Happened, The Stock Market Crashed

Wolf Richter's picture

Wolf Richter

The last two times when margin debt reversed and fell after a record-breaking spike, all hell broke loose. In 2000, it was simultaneous. In 2007, it was delayed by a few months. Today, on the surface, everything is still hunky-dory. The Dow is just fractions below its all-time high that it set on Wednesday. But beneath the surface, parts of the stock market are already coming unglued, and holders of momentum stocks have been eviscerated.

The Nasdaq Biotech Index had beautifully shot up along an exponential curve. Then the hot air hissed out of it, and it swooned 21% in six weeks. The index includes big players, like Biogen, not just startups with big dreams and no drugs. After some buying on the dip, the index closed on Thursday down "only" 15%. But that hasn’t saved smaller momentum stocks: Exelixis is down 58% from its 52-week high and 92% from its all-time high shortly after its IPO in early 2000; Halozyme is down 60% from its high in early January. And so on.

In the social media space, the bloodletting has been ugly. The Social Media ETF SOCL is down 23%, but stronger stocks like Facebook (down 16% from its high a month ago) paper over individual fiascos, like Twitter, which has plummeted 48% from its peak last year to below its IPO price.

Other momentum stocks are getting annihilated: Amazon down 25% since January, Netflix down 27% in just two months. From their peaks, Pandora crashed 39%, Gogo 63%, and Imperva, a Big Data security outfit, 65%.

Then there’s the “Cloud,” the single most hyped miracle-sector last year. Escalator up, elevator down. Workday, which sells cloud-based corporate software, went public in late 2012 and soared. Two months ago, it sprung a leak and the hot air hissed out of it. It’s down 36%. Veeve, which sells cloud-based healthcare software, has crashed 60% from its November high, shortly after it had gone public. Salesforce is down 22%. ServiceNow lost 30% over the past two weeks. LinkedIn reported a loss after hours on Thursday and got hammered. It’s now down 40% from its peak last September. Jive Software is down 71% from its high in 2012.

They aren’t just outliers. They’re included in the index of 37 publicly traded cloud companies that VC firm Bessemer Venture Partners put together and updates on a weekly basis. From the beginning of the data series in January 2012 to February 27, 2014, the index had soared 129%. But in the two months since then, the index gave up more than half of its gains and lost $58 billion in market cap! 

Dizzying hype, smoke, and mirrors allowed Wall Street and Silicon Valley to slap crazy blue-sky valuations on startups that are all now trying to go public, 34 of which, at last count, have valuation of $1 billion or more. Airbnb, a bed-and-breakfast site, and Dropbox, a cloud software company, top the list with valuations of $10 billion. CIA startup Palantir [read.... Surveillance Society: If You Drive, You Get Tracked] has a valuation of $9 billion.

By comparison, Box's $2-billion valuation doesn’t seem like a lot. But it’s a tiny money-losing outfit offering cloud-storage and collaboration software – a glorified online file cabinet – in a crowded sector with low barriers to entry, dominated by huge companies such as Google and Microsoft, and populated by startups such as Dropbox. Not exactly promising. In 9 rounds of funding, it raised a total of $399 million. One thing it does really well: burning cash. Last year, it burned $92 million. As of January 31, it had $109 million left. People are already projecting the out-of-money date. So it would be helpful if this thing could be dumped before then into the lap of a blindly adoring public.

But that blindly adoring public has evaporated apparently. And so Box decided to delay its IPO until June or later, the Wall Street Journal reported. "Since filing, we've planned on going public when it makes the most sense for the market," a spokeswoman explained. And apparently, Box’s $2-billion valuation in this crashing cloud market doesn’t make enough sense.

There may be another option for it. Surely if Facebook forked over $19 billion for WhatsApp which has negligible revenues and 50-some employees, or if Google blew $3.2 billion on Nest, which is trying to market a home thermostat, why not blow some megabucks on Box. But what if the big players are seeing what everyone else is seeing, which is a crash back to reality? They might not feel like propping it up singlehandedly.

Just then, the one thing that wasn’t supposed to happen happened. Margin debt declined.

Margin debt, after it has been spiking for months, has a nerve-racking habit of peaking right around the time stocks crash. In the last fifteen years, it had three majestic spikes, each greater than the prior one.

It began to spike in January 1999 during the final throes of the dotcom bubble. In March 2000, it hit a record of $278.5 billion, or 2.66% of GDP. In April, it declined. An epic stock-market crash had just started.

It began to spike in September 2006 to max out in July 2007 at $381.4 billion, or 2.60% of GDP. In August, it declined. In November, the fetid air started hissing out of the market. Momentum stocks got killed first, and as they plunged, margin calls went out, and forced selling set in, and the selloff turned into a rout.

In August 2012, margin debt spiked again, and this time, it turned into a phenomenal spike that set a new record in July 2013 and continued going for the stars. In February, it hit $465.7 billion, 22% above the prior all-time record. And 2.73% of GDP. The highest ratio ever!

It isn’t the spike per se that matters, but when the spike reverses. So in March – the New York Stock Exchange released the numbers Wednesday evening – margin debt declined by over $15 billion. Instead of plowing $15 billion in barrowed money into stocks, as they might have during the upward momentum of the spike, investors yanked out $15 billion – for a difference of $30 billion compared to prior months. And that moolah they yanked out doesn’t sit on the sidelines. It dissipated into thin air by being used to pay off debt. The last two times that reversal happened, the whole construct came tumbling down.

Parts of the market have already tumbled. Momentum stock traders have taken a drubbing, and some of those who trade on margin received margin calls and were forced to sell, and others dumped their positions to avoid getting wiped out. It’s bloody out there, in momentum stocks. They’re the ones that go first. And the last two times, they didn’t go solo.

That’s how it always starts: with a deadly mix. Home sales are collapsing while inventories are soaring in six housing markets that had been white-hot just a few months ago. Read.... Implosion of Housing Bubble 2 Hits Six Cities in the West

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aka_ces's picture

Wolf, a graphic suggestion: the margin debt chart is great, and I think it would even more telling if you were to graph the ratio of margin debt divided by $SP500.  And add an overlay w/ the $SP500 chart. 

dontgoforit's picture

We bailed a little early - at 13,800, for a 3% MMF.  Not much return, but we sleep better.

AdvancingTime's picture

 If the world gets twisted into an economic pretzel a big focus will shift to the topic of "value and worth." The value of "something" is not an issue to take lightly. Value is not a constant and can be derived from several factors such as supply and demand or utility value, things can spoil or become obsolete making where you invest very important.

Value is not as constant as many people think or always destined to rise. The whole concept of value is also deeply rooted in "relevance" meaning drinking water is very valuable to a man dying of thirst. More on what constitutes "real value" and why it is important in the article below.

Comte d'herblay's picture

There are many things that do not change in their real, high value to us:

The nail clipper, unsurpassed in a hundred years, paper clips, Chinese food, Navel oranges, the Philips screwdriver, the lathe, the wheel and what it gets put on, Automatic perfectly timed traffic lights, Frasier, Nose and ear hair trimmers, Automatic .223 weapons, The crossbow, Trojan Horse, diamonds are forever, the big Mac, TIVO, the 30 second commercial by pass. the heating pad, gravity, Espresso, heterosexual sex......and on and on and on.

Value is constant in so many things that truly matter, it's impossible to think of life without them, a good mother's love being at the top of the list. 



shovelhead's picture

Kinda like Soca dancing in a dark nightclub with that hot Latina when the lights come up and you see her makeup running from sweat and the wrinkles tell you she's over 50 instead of 25.

Bloated valuations are like that sweetie and margin debt is the lightswitch.

Keep dancing while the music plays but the band is getting ready to go on break.

Herdee's picture

Highest margin debt in history combines with tapering until finished and then comes negative real interest rates as the final attempt comes in a failed effort to avoid bad government debt worldwide.Oh.I'll add in coming austerity to all expected government services because of endless useless wars."We're broke!"

rsnoble's picture

Did I just read that right?  A fucking $10 billion bed and breakfast???

Other than that the FED will lie all the way to DOW ZERO.

AdvancingTime's picture

QE may just about run its course and we may soon be forced to face our economic Armageddon. The forces that have driven stock markets ever-higher and upward may be beginning to wane. Many markets became distorted years ago when QE and super low interest rates hit the economy in an effort to lessen many of the missteps of recent years.

The policy of QE it now appears has been more helpful in holding up the underlying value of assets and derivatives than helping to repair a wounded economy. Unfortunately the economy has not fared as well as these asset prices and in many ways these policies have harmed Main Street. More on this subject in the article below.

toadold's picture

It's kind of like speculators buy on margin and investors are supposed to buy with cash and buy for the long term but now you have people calling themselves "investors" who are buying on margin mainly out of fear as much as greed.  So it looks like when the market drops its pants and does the dump it will rain down on today's retail crowd. The real speculators will bail out before everybody else or at least be the first so they'll have a cash cushion, the rest will drown in the poo.  I give no financial advise because I'm obviously not rich. 

dontgoforit's picture

When all the rules have changed in the middle of the game, and continue to change with every minute, there is no advice that is good to the point of maturity.  If you have any investment money, go safe until this either straightens out or grinds to a halt.  My gut feeling has been for a couple of years that what happened in '06 was just a dry run of how things would go next time, except the bounce will not be as immediate nor as strong, not for a long time.  Us old folks especially have to be cautious as we don't have the time to absorb the hit and come back.

Riprake's picture

If this is anything like last time, the crash will happen in 2014, but the regular guy on the street won't notice things are any worse than usual until 2015.

BandGap's picture

In the '29 crash the worst years were 1933 & 1936.

What is interesting is that Rooselvelt and his band of merry idiots pulled all the rabbits out of their hats AFTER the crash. This go around all the BS is happening before the crash. The only ammo they will have to address shit after the crash is actually real ammo, not some academic QE move.

losingconsciousness's picture

Hmm. So the author is saying "In the last fifteen years, it [margin debt] had three majestic spikes, each greater than the prior one." But the graph shows higher highs and higher lows each time, therefore there is an ever-upward trend over time with periodic corrections same as the stock market. One cannot identify a majestic spike until after it has occured, therefore one cannot predict when a spike will occur. In summary, there is no predictability at all, just the ability to observe the past in hindsight. In fact, there is really no bad news long term since the trend over the long term is up. Remember the observation, "why is it that I always find lost items in the last place I look?" Because one quits looking once the item is found. Same for a spike, "why is it that I always find a majestic spike in the last place the margin debt went up?" Because it had to go down in order to create a majestic spike. Prediction of margin debt spikes and market tops is an exercise in futility.

Lost Word's picture

The point is the spike which is higher than the previous spike,

then beginning to decline, as a sign of impending crash.

But there must be some chance that the next spike crash would be a spike which was lower than the previous spike crash, because of different current circumstances.

Sambo's picture

The graph shows an unambiguous rise in margin debt after the the collapse in 2000/2001.

You dont see the same kind of upward swing after the July 2007 peak. There are lots of little peaks after 2009 but they never synched up with any notable crashes.

TheRideNeverEnds's picture

Adjust that for inflation and we would probably still be below the 2000 peak margin debt.  However nice call on the swift reversal from the spike.  I tend to agree with your assertion by the way bonds have been trading and the fact that I just shorted a load of them which means they are likely going sharply higher from here; back to 140 maybe and we all know what that would mean...

Setarcos's picture

Wolf always posts good and straightforward information I find.  One of the best contributors in ZH I think.

I Write Code's picture

The market will go where the fed tells it to go, and vil like it!

q99x2's picture

Good article. I think you are right Wolf.

willwork4food's picture

Great article. Now I will need a extra few beers to calm my nerves thanks to Wolf. I work construction/remodeling and we kicked ass in 2007..UNTIL Nov. 1st and things just DIED..for months...and months and months, all while gas prices continued to creep up, and up-just like it's doing today. AMOST $4/GAL bitches! This sucks Obama dick.

BandGap's picture

I no longer need to be calmed, and I don't discuss any of this with Shiny, Happy People. We are on Act VII of a ten act play. Wasted energy other than prepare those that I have influence with and enjoy the view.

When you don't have a job, the cost of gas means little.

JustUsChickensHere's picture

$4  ... Americans !!!     Try $8.65 per US gallon here in the UK  (£1.35 per litre)

Cloud9.5's picture

But my British friend, how far do you have to drive to work?

MaxThrust's picture

The Fed still has the ability to halve interest rates.


That, probably was the nature of their most recent (closed) meeting of the FED


The ( Federal un-opened market committee )  FUMC


The Tribe will triumph until there is nothing left, then the revolution will start.

HardlyZero's picture

Thank you Wolf.  I'm feeling good in my shorts now.  It has been a year waiting, but started getting short in 2014.

kellycriterion's picture

Knowing who the real bag holders are, isn't crucial to the main point of this article. So why posit "momentum traders" if you don't have facts? It plays in Peoria?

ebworthen's picture

Thanks for the cogent analysis Wolf.

Margin debt is a lot more important than Chipotle or Facebook.

And Ye Olde FED actually cut QE by $10 Billion again this month. 

Zero QE and prime rate at 6% Janet - go on - I dare ya'.

HardlyZero's picture

...and...The "Unemployment Rate" is diving down as more people leave the workforce " !!!"

Can now see the valley bottom getting closer in the free-fall.

The man with pointy horns's picture

I double dare ya' motherfucker!

besnook's picture

this time is different. the other data sets were pre qeternity. margin should be able to sustain some number above 2.6% of gdp. in other words there should be more room for an even bigger bubble this time, the mother of all bubbles, mother bubbles, a wornout tramp with a cockled pussy.

Ham-bone's picture

ez way this will be resolved (for now) is another big push down of interest rates...don't try and think like this is a market or any such quaint idea.  Just think what is needed for ever greater leverage and credit...ability to roll it all over at half in the interest payments.  And so it shall be.  Look for sub 1% 10yr interest rates within a year. (think I'm turned Japanese).  Not because there are any buyers..but because that is the only manner in which the whole system can have one more turnover before something gets really serious. 

One more refi boom, one more push upwards of housing, one more coprorate and gov rollover into virtually free debt...the bitch of all this waits on the other end in all the owners of this debt who are going to get zero yields...but not to worry cause that's still a couple years away...carpe diem.

besnook's picture

in the past the fed has admitted the lag time for the effect of its operations is a known unknown. the same explanation is given about the size of the effect. so they have admitted they don't know what they are doing but they know what they are doing will do. as has been mentioned many times here, the fed is trying to achieve escape velocity for the economy using an array of aggressive, out right manipulative, bid and ask rigging, worldwide monetary policies trying to force the market to comply with its wishes at the expense of the people and the benefit of the .1% featuring massive asset destruction cushioned by massive money printing and fantasy accounting, in effect, saving the world from the collapse of the wealthiest people in the world. it has been clear what world the intent was to save.

well, lookie here. they may have just pulled it off before your very lying eyes. the normal cycle is a really simple cycle. yields go down, market tanks. yields go up, market rocks. it has been done like this since the dawn of man. the easiest gauge is the retail mortgage market. during the last interest rate cycle mortgage rates went as low as 3.25 and just rounded the top at about 4.5. interestingly a mortgage interest rate chart dating to the 50s-early 60s shows borrowing rates in that range with an approximate average of 5-5.5%. my point is this cycle will have to bottom above the previous bottom and go a bit higher than the previous top and the fed will declare victory. this timing also coincides with the bottom of the units built chart.

you have to be impressed if they pull this off despite all the continuing massive distortions in the market.

ElvisDog's picture

I disagree. As Denninger has been writing, the combination of low interest rates and peaked stock market values is lethal for insurance and pension companies. The evidence that the Fed is aware of this situation is the continued taper despite iffy-at-best economic data. I'll take the over on your 1% 10yr interest rate bet.

willwork4food's picture

Agreed. Also look for 30yr term New Car loans and 50 year housing morts. Then they will have most of us by the balls.

Fuh Querada's picture

I used to have a girlfriend named Marge Inkall.

Ban KKiller's picture

With all the "money" out there do these numbers mean what they seem to show? 

Guess so, numbers don't lie. No matter I did not buy the dip. Won't buy the dip. Only dips play in a rigged market?

Soul Glow's picture

Janet Yellen's mind is in the Cloud.

krispkritter's picture

Bad mental image! Mental Floss! Mental Floss!  Too late. I'm ruined for life.  Thanks to you I'll never have sex with a white-haired Sasquatch Beeyatch again...

PT's picture










Do you still have both your arms?

krispkritter's picture

No.  I'm typing this with my knob...

PT's picture

And it sounds like you're lucky that you still have your knob.  Ironknob?  Knob of steel?  Adamantium Knob? ...

HardlyZero's picture

Maybe if things get really bad they will replace Yellen with Christine Leg-arde in a G-string and black leather.  (fixed?)

Debt-Is-Not-Money's picture

Where the hell do they get these people from???????

Comte d'herblay's picture

Where do the Sicilians get their Mafia Dons?

In this case, only members of AIPAC need apply. 

Colonel Klink's picture

1-800-need another criminal bankster hooker bitch.