Margins of Bearishness?

Evidently, this bull market is on borrowed time—literally. At least, that’s what some headlineswarned after the NYSE announced margin debt hit another all-time high in January: Folks are borrowing en masse against their brokerage accounts to buy stocks, turning the bull into a margin-fuelled bubble. Suffice it to say, we disagree. Margin debt is a useful sentiment indicator, but the absolute level alone is darn near worthless as a forecasting tool. In our view, nothing about the current level indicates a crash is coming.

The margin hysteria largely ties back to 1929. Many incorrectly believe massive margin debt caused the crash—a classic case of conflating coincidence and cause. Margin likely did contribute to the speed of the ’29 crash, as the decline forced liquidations to cover some margin calls. However, the bear had its own fundamental causes (among major factors: a coming recession met with monetary policy errors and the Smoot-Hawley Tariff). A rapid rise in margin as stocks neared their peak was simply one marker of the day’s widespread euphoria.

Nothing about today’s margin signals euphoria. Margin bears point out today’s levels dwarf the margin peaks in 2000 and 2007—which occurred near market peaks—but today’s market cap dwarfs 2000 and 2007, too. (Plus, investors weren’t at all euphoric when the last bull ended in 2007.) Margin debt might seem astronomical at $451.3 billion as of January 31, but NYSE market cap that same day was $20.4 trillion.^[i] Yes, margin debt is growing—but so are stocks! Many indexes globally are at all-time highs, too—it’s normal for the two to move in sympathy. Consider: NYSE margin debt first passed its pre-crisis peak in April 2013. Then, it represented 2.1% of the NYSE’s market cap. January’s margin level was 17.4% higher—but only 2.2% of market cap.^[ii]

Furthermore, margin levels say nothing about what the money is being used for. No doubt some folks are making a leveraged bet in their portfolios—inadvisable, in our view, but to each their own. But some of those bears warning of margin mayhem could very well be using margin to short the market, ironically contributing the very signal that scares them. That’s not euphoria! Other folks don’t use margin loans to invest at all—rather, they withdraw the funds. Simply, with so many potential uses for these funds, and no way of knowing which is getting the most traction, using margin levels to determine investor behavior is folly.

In our view, a better way to interpret margin is the magnitude and rate of change—how fast are margin levels moving up or down and how big are these moves? If there were a quick, massive increase in margin, it could very well be sign many more folks are using margin to make a leveraged bet—a sign of euphoria. We aren’t seeing that sort of spike today.

But even if margin growth were to escalate exponentially, that alone wouldn’t necessarily spell B-E-A-R. The total picture is what really counts. Typical bull market peaks are characterized not only by spiking margin debt, but by super long-range profit forecasts, wild extrapolations of recent positive performance in the media (e.g., Dow 30,000), lofty forward valuations and faltering fundamentals. With the economic and political backdrop still plenty strong, and neither margin nor any other sentiment indicator signaling euphoria, the chances a bear is nigh are slim to none.