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Margin Debt Drops: Healthy Pullback, Or Budding Headwind?
Pullback in Margin Debt is healthy... unless it signifies the start of a larger decline.
In our post yesterday on household stock investment, we discussed what we call “background indicators”. These various investment metrics describe the longer-term conditions in the marketplace, but are not catalysts themselves. Thus, we consider them to be measures of potential risk should a catalyst come along to trigger a decline. In that case, the potential risk begins to manifest itself in actual risk. Considering it is near its all-time highs, we consider household stock investment to carry significant potential risk. Another background indicator signaling the same is NYSE margin debt.
Margin debt refers to the amount of money borrowed for the purposes of leveraging a stock position. The higher the level of margin debt, the more leverage in the system – and the greater the amount of potential risk. As of April this year, NYSE margin debt was at an all-time high at more than $500 billion. Over the past few months, the level has moderated a bit. After August’s market rout, margin debt sat at $473 billion, down 6.7% from the highs.
So is this a healthy pullback in potential risk? Or is it a beginning of a larger trend whereby more potential risk will become actualized risk? There is no way to know for sure, however, there have been a few similar declines in margin debt in the past 15 years. Specifically, since 1999, NYSE margin debt has seen a drawdown from its high of at least 6.7% on 4 other occasions
- April 2000
- August 2007
- May 2010
- August 2011
Obviously the first two instances saw the pullback morph into substantial, longer-term retrenchments, coinciding with cyclical bear markets in stocks. The other two occurrences, while coinciding with painful stock market pullbacks at the time, did not lead to a longer retrenchment in margin debt. And, in fact,by the time we knew what margin debt had done in May 2010 and August 2011, the correction in stocks was almost over.
There are obvious similarities between the 2010 and 2011 instances with our current situation, especially 2011. So it is entirely possible that the current market pullback has almost run its course. However, there are also differences. In 2010 and 2011, neither the stock market nor margin debt were at all-time highs. They were in 2000 and 2007, however.
So which is it? We can’t know but there is one thing that may be relevant to keep in mind. Considering the elevated near-all-time high readings, if it is the beginning of a larger decline in margin debt, the resulting move in margin debt and in stocks will be much larger than that of a mere short-term correction. Thus, while the odds of each outcome may be equal (as far as we know), the consequences of each are much different.
In any bull market, certain excesses are built up during its duration. The build up of these excesses, in metrics like margin debt, can serve as a tremendous tailwind for the market…as long as they continue to rise. However, when the music stops and the market declines, these tailwinds become headwinds. This is particularly true of margin debt as margin selling necessarily exacerbates the damage in a large decline.
We do not know for sure if the recent margin debt retrenchment is the beginning of a longer trend. However, given the record high levels it recently achieved, should a longer, more serious decline in the stock market be starting, the large potential risk represented by record margin debt levels will turn into large actual risk.
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Sooner or later you run out of other people's money.
The house always wins.
Just because the corpse twitches doesn't mean its ready to run another marathon.
OK CAN I SHARE WITH MY "PEEPS" FOR A BREIF MOMENT HERE. THIS DANA LYONS SIMPLY "DRIVES ME INSANE". EVERY ARTICLE AND EVERY ANALYSIS IS COUCHED WITH "SO WHAT DOES THIS MEAN - UP OR DOWN"?
DANA - GET SOME BALLS [OR AT LEAST SOME LADY BALLS] AND SAY THE WORD "DOWN". NO ONE WILL TAR AND FEATHER YOU IF YOUR ANALYSIS HAPPENS TO BE JUST "SHY" OF PERFECT.
This will cause even more selling pressure, the likes of which no zerohedger has every seen in his/her lifetime.
Screw Dana Lyons. She sounds like a fool. Hey another idiot is ramping the gosh dang market into the close. Why do they do that over the weekend. Is something supposed to happen. Nobody tells me nothing. UVXY +6.66%
Hey, how bad can she be? She posts on Tumblr... oh... that bad.
....dont forget the Securities Based Lending debt...barely existed prior to 2009, now is almost as much as margin debt.
at first a little; then all at once.
According to Itau BBA:
http://is.gd/XzTkOs
The Big Fear
Thus, Fed announcement day arrived with most equity markets up 5%-10% off the late August lows, commodity prices higher and rates priced for Fed action. The main concern coming into the Fed meeting was not that the Fed would hike; it seemed quite clear that it would not go against virtually the entire global economic policymaking community and raise rates. No, the concern was that the Fed would stand pat and stocks, rather than rally, would sell off.
Lo and behold, that is exactly what happened, and that is why we need to be very, very concerned about how things move from here. It remains unclear whether the equity market reaction to the Fed decision was (hopefully) just a classic case of buy the rumor (no hike) and sell the news, or something much worse, namely that investors might be starting to price in policymakers? loss of control – The Big Fear.
The Big Fear of policymakers losing control has been lurking underneath the global equity market for years, underpinned as markets have been by central bank support. Think of it this way: there are two global growth drivers: China and the US. Recently, the competence of the policymaking community in both countries has been called into question, suggesting a possible loss of faith in policymakers, which if true is very worrisome, thus the Big Fear concept.
Why is the Big Fear so worrisome? It’s simple. If investors lose faith in policymakers and decide that cash or bonds are a better place for their money, then stocks are likely to sell off much further. How much further? One never knows, but maybe asking a few questions might help. First, at what level does the S&P need to be for the Fed to engage in QE 4? Second, what S&P level will be considered cheap (keep in mind 2016 E estimates need to come in sharply)? I don’t know the answer to either question, but it seems reasonable to expect that the S&P would need to go much lower than the 1870 level it bottomed at in late August or the 1830 level of a year ago.
The economic implications of such a sell-off would likely be a US and global recession. Such an environment could create a negative feedback loop between financial markets and the real economy, which policymakers would find very difficult to break.
It seems clear that the Fed will not raise rates this year, neither next month when they meet again nor in December, which is the last meeting of the year. Will they raise rates in 2016? From this armchair, the odds are against it, as the forces of recession gather while the forces of reflation stagnate. On this front, one has to question the Fed's 2016 inflation forecast of 1.6%, up from 0.4% this year. The Fed’s crystal ball has been mighty cloudy for years, but this forecast takes the cake.
A look at the global economy helps explain why. Four factors stick out: excess debt, an absence of inflation, insufficient demand and excess supply of raw materials and manufactured goods. None of this is new – what is new is how the various hopes and remedies have fallen short while the problems deepen. The toxic combo of excess debt and disinflation is one powerful reason why the Fed did not move, and excess supply in commodities and manufactured items (look at the PPIs around the world) is another. The global economy needs demand-creation or production shut-ins, and to date both have been lacking.
There are small signs that the commodity complex is starting to finally adjust, with closures, dividend cuts and stock issuance in the mining sector and talks about talks in the world oil market. However, the manufacturing segment of the world economy is quite far behind the commodity segment, suggesting that China's need to shift excess production will ensure manufactured-goods disinflation for the foreseeable future.
One can wish for inflation and for the Fed to be able to hike, but one also needs to be focused on the realities of the current global economy. Where is the demand going to come from? Who is going to shut in production? Let?s look at the three main economic regions: Asia, Europe and the Americas. Asia is likely to be a source of manufactured-goods disinflation as it seeks to rebalance itself to a China that is a competitor first, a customer second. Japan's recovery is sputtering; it will continue QE while a fiscal stimulus package seems quite likely in the months ahead. Europe remains quite weak, and with the refugee issue now occupying policymakers, ECB-led QE seems the only game in town.
The Americas is a concern. South America is in a deep funk, whether it is Mexico's subpar growth rate, Brazil's political and economic travails, Andean copper dependency or the impact of weak oil on countries such as Colombia or Venezuela. All this is pretty well known.
The US is most worrisome because of its combination of still-high equity prices and a very bare policy toolbox to confront any economic weakness. How bare? Well, monetary policy is on hold, and the bar to QE4 is likely a much lower S&P. What about US fiscal policy, one might ask? Great question. Here is the only thing one needs to know about the US presidential election process: it takes fiscal policy flexibility away and locks it in the freezer until late 2017, two whole years from now. In other words, at a time when the US economic expansion is close to seven years old, with the Fed on hold, incomes flat, debt levels high, a strong dollar and absolutely no inflation, fiscal policy is locked away for the next two years at least!
By the way, the UK confronts similar issues and could possibly be a canary in the coalmine for US monetary policy – QE for the people on BOTH sides of the Atlantic perhaps? The UK's negative rate discussion is likely to move across the pond over the next quarter or so. One other way of thinking about it is this: which comes first, the end of ECB QE or QE4 in America? I would go with the latter.
How does one vanquish the Big Fear? With aggressive policy action on the demand-and-supply side. What is the likelihood of that? Exactly. Seen in this light, it makes perfect sense for investors to worry that policymakers no longer have their back, and thus they take some money off the table. One analogy is that the US economy is like a ship that has engine trouble, is drifting towards the rocks and is left to hope that the wind shifts and takes it away from the reef…. not exactly a bull-market, high-valuation tableau. Hope is not a strategy.
WHEN margin debt drops to 200 and people are THROWING themselves off rooftops - then I will believe that you've got a real pullback.
Great pic of a crow on the real website ... learning how to soar on wind currents ... was that the real meaining of the article? Crows learning to hover/hunt like seagulls? If you haven't seen gulls hunting for food along the CA pacific coast headlands, none of what I typed will make sense.
;-)
The 2010 and 2011 stock price points are sufficiently recent to provide meanful benchmarks for where the S&P 500 should be (assuming that these companies have not made fatal mistakes and that new entrants are not killed off by excessive regulation and a hostile economic environment). That said, there appears to be about $200,000,000,000 in margin debt that has to be absorbed. Taxpayers will have to earn about twice that much just to pay off the taxes on the income to cover that loss. I doubt that such income generating capacity is likely. The result will likely be bankruptcy for most, and bailouts for some.
Margin debt drops but derivative action increases?