Margin Debt – setting up a S&P 50% plunge?

FINRA margin debt is a long-term indicator and always reported a month late.

So now we have the August numbers, down 6% month over month, as reported by Advisor Perspectives Monday (see the chart below). But it’s not the margin number that is concerning, it’s the chart pattern for the long term.

In the 1990s margin debt chugged along in a reasonable bullish fashion before finally going ballistic in 2000 just before the dot-com bubble burst. Then again, coming out of the 2003 bear market, it moved up gradually before going ballistic again in 2007 on a bubble in housing, fueled by excessively low interest rates for too long a time, and we had the financial crisis of 2008/2009. And now in 2018 margin debt has pushed higher than ever before on deregulation and tax breaks to corporations fueling stock buy backs, and some would say on a lot of hot air.

It the fall of last year it topped and has not gone higher this year. That is ominous for long-term investors.

Consider the pattern on the chart below.

Note that in both 2000 and 2007 the market made a new high after margin debt topped and fell. Each time on the chart, the debt numbers formed a plateau lower than the peak as the market made those new highs.

What comes next?

That is always the most important question in the stock market.

In 2000, the S&P plunged 50% (the Nasdaq, 78%), and in 2008 the S&P plunged again down 56%. Note the pattern in place on the chart now. Same old same old.

So is another 50% bear market imminent? It’s likely because although they always say it’s different this time it never is, even though it sometimes takes a long slow time to get it done.

This is a bit tricky at the moment because of the late reporting. One has to guess what is happening with margin debt behind the monthly market moves. Since the August drop in price is reflected in the margin debt drop (big professional players lightening up, maybe desperately lightening up), and since the market has rallied so far this month, one can guess margin debt may move up a bit here in September but not a enough to head off what is to come.

And since the market likes to fool everyone into complacency at the last possible moment, a new high here would probably be just enough to lock long-term investors in when they should be at least shuffling, if not running, to the exit.

If by chance it doesn’t move up, October could become an October of old, which is to say…uh, crash… crash… crash.

(click on the chart for a larger view)

Declining Margin Debt – the bullish scenario

Margin debt, money borrowed to leverage the market, has for now topped and is in decline. Before the top in February it had reached levels far beyond the surges in 2000 and 2007, which could be an ominous indication of what is to come when and if margin debt continues to unravel.

See the chart below and the charts in the link.

Does the fact that it is coming down as major players try to ease out of their leveraged positions mean the market, measured by the S&P 500 stock index (SPX), has also topped? For the time being it would appear it has but history would say that’s not necessarily so.

MARGIN DEBT AND THE MARKET

From the link:

“The first chart shows the two series in real terms — adjusted for inflation to today’s dollar using the Consumer Price Index as the deflator. At the 1997 start date, we were well into the Boomer Bull Market that began in 1982 and approaching the start of the Tech Bubble that shaped investor sentiment during the second half of the decade. The astonishing surge in leverage in late 1999 peaked in March 2000, the same month that the S&P 500 hit its all-time daily high, although the highest monthly close for that year was five months later in August. A similar surge began in 2006, peaking in July 2007, three months before the market peak.”

Simply put, that would mean there is at least another new high coming in the new few months (the summer rally?) before any significant bearish behavior in the stocks.

The heads up is to say those highs, if they come, will be opportunities to sell, or at least tighten stops on long-term investments. A second look at the chart shows that the SPX, coming off highs in margin debt, declines close to 50%. Those were real bear markets. The next one could be worse. Regardless, no matter how low it goes, it is best to be avoided.

There are two possibilities it could be somewhat different this time. One, margin debt itself could surge to another new high along with a strong months-long market rally (see the jingle-jangle in 2015 on the chart); or two, the top is already in and the next leg down (given how astronomically high the margin debt is beyond 2000 and 2007) could be a dead bull dropping right out of the sky (they can not fly forever).

(click on the chart for larger view)