Don’t Sweat Margin Debt

Source: Investech


One data point that has found a home among the bearish community is the total amount of New York Stock Exchange margin debt. It is at record highs, and this supposedly means the end of the bull market is nigh.

The cyclical bull that began in March 2009 may be getting long in the tooth, but margin debt is not what is likely to do it in any time soon. Margin debt has been one source of fuel that drives equity prices higher.

The danger, according to Jim Stack of Investech Research (of Whitefish, Montana), is when that margin debt begins to fall relative to gross domestic product. As the chart shows, when margin debt as a percentage of nominal GDP makes a peak and then reverses sharply, that is your danger signal.

Those circumstances do not exist presently. As Stack notes, “Margin Debt as a percent of GDP hit a new high during September on the back of improving investor confidence. However, history shows that if there is a steep decline from this elevated level (green arrows on graph), it could be ominous for the market outlook.”

Margin debt, despite the whining from certain camps, is not currently a problem. But a major reversal in margin often means that much less buying power underneath equities, or worse yet, forced liquidations. If and when that happens, look out below.

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