A Market Indicator That Predicts Nothing
Its predictive value is minimal.
Bloomberg, April 29, 2015
Every now and again, a way of looking at markets suddenly gains traction. Data gets assembled, analyzed, reviewed. Eventually, it becomes the basis of traders’ decision-making process. It even can become part of Wall Street lore.
The problem that arises all too often is that this approach is statistically bogus. The data gets cherry picked; backward-looking analysis gets form-fitted to what just happened and has no meaning for what is most likely to happen in the future. Confirmation bias and selective perception can lead an investor to lose objectivity, choosing an approach that justifies an existing portfolio mix, as opposed to objectively evaluating the data.
Consider as an example the ominous-sounding Hindenburg Omen, a technical analysis that purports to signal the likelihood of a market crash. That’s exactly what it’s been doing — unsuccessfully — since 2010. This sort of recession porn allows people to confirm their existing prejudices. After five years of money-losing forecasts, theHindenburg Omen’s following among traders is fading.
But many other dubious or disproven metrics are still out there. Consider the Murdoch Indicator, or the Super Bowl Indicator, or theMascot Indicator or even the Ticker Tape Parade Indicator. A decade ago, I termed this phenomenon YAII — for Yet Another Idiotic Indicator.
The most recent such metric? New York Stock Exchange margin debt. (Margin debt is when an investor borrows against the stocks he owns to buy more shares.) Margin debt has reached an all-time high and, as we have been told repeatedly, this is a fatal sign for markets.
There are two problems with this: The first, and lazier criticism, is to point out that analysts have been discussing the danger of this for at least the past four years (see chart below from two years ago). Margin debt was cited as a precursor to doom in 2011 and 2013 and last yearand again a few days ago.
The more substantive analysis is to note that this is a correlationwithout much predictive value. It is a coincidental, not a leading indicator. Check the historical data and you will find it gives little warning of an imminent market crash.
Let’s delve into the details:
Continues here: A Market Indicator That Predicts Nothing
That is nominal debt, which is the key. When you adjust it for inflation, it is around 1200.
I get it that the level of debt doesn’t predict when (or if) the market will fall. But it is one more bit of tinder that will accelerate the fall if it occurs. The big kahuna is demographics, 30 million baby boomers (who have probably 4x the assets of GenX and the millennials combined) either retired or within five years of it who won’t want to be the last person through the door.
The updated chart (our host presented the old one to show that this isn’t a new worry) is at the ” few days ago.” link. Currently, the net margin debt is twice what it was in 2007 and 30% higher than in 2000. There’s no reason, though, that it can’t get twice again as large as it is now.
1999-2000 proves that nothing can be used to predict an exact top. However, I think margin debt is useful for assessing how bad the next bear may get. This level of margin debt indicates that I wouldn’t bet on it just being a 25% drop.
Your not adjusting debt to inflation. The level is not 99-2000 level.
99-00 was also off the charts insanity. I spent much of 99 trying to find mutual funds that had 20% technology or less because it was clear that tech had gone utterly insane – that led me to a portfolio of old-fashioned Graham & Dodd value funds. I think much of the margin debt in 99 was for tech purchases which probably is one of the reasons it got as high as it did and then collapsed 80% while the boring industrial and service companies generally only dropped around 20% or so. Margin debt in 2007 and today is probably spread across most of the market.
Great job at debuking bogus indicators. Nobody can predict the future, so why not just follow the trend.
Coincidental indeed. Identify any datapoint that is not. Hold on to your wallets.
Maybe I remember wrong, but there seem to be hedge funds, and in particular algorithmic” based trading hedge funds, that have leverage ratios over 50, in order to multiply returns on base capital, as long as momentum lasts.
As someone in previous comments remarks, when momentum stops this could mean very huge reversals.