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Margin and Those Record Highs

Tim Knight from Slope of Hope's picture




 

From the Slope of Hope........

I've been fiddling with some numbers in Excel and thought you'd find it interesting. It concerns the correlation of NYSE margin debt with the S&P 500.

Margin gives investors and traders the opportunity to borrow money in order to enhance their returns. NYSE margin debt concerns the aggregate value borrowed by all participants utilizing that particular exchange.

The figures shown will be in millions, so $400,000 is $400 billion; big moolah.

I became interested in margin debt after I had seen the following chart plastered on a few trading websites. Many of you may have seen it as well.

 

0330-margindebt

 

While the correlation is strong most of the time, the 2000 and 2007 tops stood out to me. Margin debt seemed to reach a peak, sell off hard, and then go nowhere as the S&Ps continued to make new closing highs.

Not being satisfied with just a chart, I collected data as far back as 1996 and threw it into a spreadsheet. NYSE margin debt data:  (buuuut it’s easier to Google search “NYSE margin debt”) SPX close data provided by Yahoo! Finance (other sources are available).

First off, lets see how the correlation held during bull markets:

0330-bullcorr

 

And how about those bear markets?



0330-bearcorr

 

So what if I cherry pick the topping periods?

0330-topping

 

And here is a chart of the 12 month rolling window plotted against monthly SPX closes. Notice in the 2000 topping area how the warning came a little early; or could this be fallout from the 1998 correction? Happily, a second warning came just after the final high close. As the margin debt data does lag (it takes a month to get published), it helps to see candles with long tails (shooting stars and hanging men) to confirm.

In 2007 we see another dive in correlation as the last high close occurs and fades away.
Now in 2014 – 2015 we are again seeing a violation of the sub-60 area.


0330-correlation

 

While this indicator does lag, that does not mean it loses its usefulness. For instance, some may argue that if the first warning in late 1998 to early 1999 were respected, a long portfolio would miss the potential for another 200 S&P points. Is that really so much? How often does one buy bottoms or sell tops perfectly? It kept the portfolio out of harm’s way.

Likewise, the 2007 top happened more quickly than 2000, so the signal was late. Even if 200 S&P points had been lost there were still another 600 to go.

For the short-side, say a trader was bearish in mid 2013. If he/she had been patient and waited for the breakdown in correlation, they would have a much better price to short at and have endured much less pain to boot!

Disclaimer:
This indicator is not the holy grail. If it confirms with divergences and oddities in other areas of the market, then maybe something really is happening here. By all means don’t mortgage the house (or reverse mortgage it).

But if the massive amount of borrowing to leverage returns is bothering you here, and you’re of the age where you can’t afford another bear market hit to your portfolio, maybe you’ll want to keep an eye on this.

I can’t wait to see how it unfolds.

 

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Tue, 03/31/2015 - 13:21 | 5945636 AbbeBrel
AbbeBrel's picture

Kudos, Dave / TK. Very nice analysis and great chart. CLEARLY the momo leveraged players are getting out of Dodge (while probably playing around on the Dax, Shanghai, HK, and Nikkei while the playing is good.

Basically as I posted earlier - my take based on this and the Buffet GDP to Wilshire / Fed Z.1 graph (link below) - is that:

The S&P has topped.

What is nice about switch hitting is that another Dshort chart NAILS the bottom:

http://www.advisorperspectives.com/dshort/charts/employment/unemployment...

or at least it has 7 times in the last 40 years!!! LOL

So (1) go to cash or short, then (2) wait for Continued Claims to peak during our NEXT RECESSION, then (3) get back in and (4) go to the beach.

Here is Dshorts Unemp chart over 40 years. Watch this space for when to Get Back In.

http://www.advisorperspectives.com/dshort/charts/employment/unemployment...

Here is the Buffet indicator. The 2015 Q1 data should show more toppy behavior as the markets are all flat YTD for 2015.

http://www.advisorperspectives.com/dshort/updates/Market-Cap-to-GDP.php
see: "Here is an overlay of the two GNP versions -- again, very similar."

Don't worry, be cash happy.

Tue, 03/31/2015 - 10:55 | 5945311 scubapro
scubapro's picture

 

 

dont forget the latest 'business line' of the "broker/dealers", er I mean, "banks":  securities based lending.   this lending is done by Morgan Stanley Bank, N.A.  and is not reported to the SEC and does not show up as 'margin' debt.  

add another $500B to margin levels and you will see how leveraged the stock market is.    the middle class got massacred last time, not its time for the upper middle and lower upper class to get wrung out.....stocks get low: margin and loan calls:  stocks dive:  more calls and the $ borrowed is now locked up in illiquid real estate with carrying costs.

Tue, 03/31/2015 - 10:15 | 5945199 centerline
centerline's picture

Great post Tim.  Will be lurking over at the slope as usual. 

 

Tue, 03/31/2015 - 05:02 | 5944739 hibou-Owl
hibou-Owl's picture

I like this article, and have been watching the same figures.

It also happened in 1987, many students were using study loans to buy shares, me included.
I sold my entire holdings to cash three days before it gapped. The article mentions the candlestick tails, well 1987 went down nine days straight before the crash, also with divergence.

just got to grind your teeth and wait for the big one. I guess the Chinese will break the market, five waves up with exhaustion gap.

Tue, 03/31/2015 - 02:13 | 5944640 armageddon addahere
armageddon addahere's picture

Blow At High Dough

Tue, 03/31/2015 - 08:35 | 5944952 MEAN BUSINESS
MEAN BUSINESS's picture

Blow At High Dough - The Tragically Hip 1989

https://www.youtube.com/watch?v=aGRNEJiD3PY

Tue, 03/31/2015 - 01:53 | 5944628 Wild Theories
Wild Theories's picture

I got my eyes peeled

Tue, 03/31/2015 - 01:25 | 5944602 emsolý
emsolý's picture

Please also do a google search for "unit root" and "non-stationary time series" before doing calculations of correlation etc.

Much of the outcome is not usable if the underlying analysis is wrong.

Mon, 03/30/2015 - 23:16 | 5944412 SweetDoug
SweetDoug's picture

'

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'

I've seen so many charts prediciting doom just around the corner, I'm sick of it.

I too think doom is coming, but the modifier on all of this is, was, and will continue to be the FED and Quantitative Easing.

The effects are just so far reaching, who knows?

 

•?•
V-V

Tue, 03/31/2015 - 10:01 | 5945165 mayhem_korner
mayhem_korner's picture

 

 

Good point.  The charts are showing what "should" transpire based on recent, similar scenarios.  But the CBs are clearly intervening on any "patterns", doing - or rather saying - whatever it will take to further levitate the "markets."

To me, it is about positioning holdings for what is the inevitable.  By doing so, the thing I am risking is the lost opportunity of the Fed being able to perpetuate the levitation longer than I exist.  The alternative is to continually seek the "signal" that things are reverting to reality, and try to beat the algos and the insiders to the exits.

Mon, 03/30/2015 - 22:54 | 5944364 FieldingMellish
FieldingMellish's picture

So.... another year to go then? BTFD!

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