The New York stock exchange regularly releases information about how much margin (or debt) investors are using to invest. Based on the latest reports from the NYSE market data, Doug Short who writes for advisorperspectives put together the following graph which conveniently compares the credit balance of investor’s accounts to the S&P 500 over the past two decades. We can clearly see some correlation between the two sets of data.
The blue dotted line represents the nominal performance of the stock market index since 1995. The set of red and green bars represents the net credit balance inside investors’ accounts. This credit balance is basically the sum of free credit in cash and margin accounts, minus margin debt. Red bars show that investors have negative credit balances (borrowing money to invest,) and green bars mean they have excess cash or credit.
Starting from the left side of the graph, U.S. margin debt slowly climbed between 1995 to 2000, and peaked in Feb 2000. A few months later the stock market began a long downward trend. The deleveraging by investors also caused a contraction in the credit supply, which contributed to the 2001 recession. A few years later investors began using debt again to buy up stocks. The amount of borrowed credit hit another peak in June 2007 and investors quickly sold their stocks to get out of debt. The stock market began to fall again, followed by another economic recession. Around 2010 investors borrowed to invest again. The credit balance peaked this time in April 2015 and has been falling since then. It’s currently down 14% from its record high set last year.
I can’t be the only one who sees a pattern here, lol. ? The S&P 500 appears to undergo a major correction each time investors deleverage and run towards cash. It’s also helpful to know that the stock market peaks tend to happen after the credit balance peaks in each of the previous cycles. Because given that the investor’s borrowing has hit another peak last year it’s quite possible that we’ll see a noticeable pullback in both margin debt as well as the stock market within the next 12 months. We could even see another recession in the U.S. soon.
Does this mean it’s time to sell stocks and buy 2% GICs instead? Not for me. And I’m guessing most of you won’t abandon your stocks either. 🙂 Those risk-averse investors who play it safe and put most of their money into savings accounts and money market funds, are the same type of people who signal in parking garages, wear the safety strap on their Wii remotes, and wait for the safety pop-up window to appear before removing their USB devices. ?
But that doesn’t mean we can’t do something to protect ourselves. I’m personally loading up on cash and defensive stocks that pay safe and growing dividends like pipeline and telecommunication companies. 🙂
Who knows? Maybe 2016 could turn out to be a spectacular year for the stock market. But the recent economic and financial news that I’ve come across seem to suggest otherwise. 😕
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Random Useless Fact:
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Interesting graph, I sure wouldn’t mind a major market correction to add more stocks at a discount.
Me too. I’m holding off buying anything in April.
Nearly every publication says the bull is coming to a rest sooner than later. CNBC published an article last week that even predicted negative growth numbers for the 1st quarter. Pipelines are an interesting pick, as the war on coal continues, natural gas will become more popular in the US than present. Spectra Energy is one that has been recommended to me because of their vertical distribution of the product.
Nice suggestion. I like how Spectra Energy has a 5.2% dividend yield.
Yup..all is not well in the financial markets. There are plenty of worrying signals…and like you, we are also following a similar approach. Stay invested in safe companies and load up on cash positions.
Hopefully a correction will provide us with great investment opportunities in the coming months
R2R
The next correction could be a big one. It’s a good thing we both invest in safe dividend stocks.
Thanks for sharing the graph and your thoughts 35. I read something similar a few days ago. More than the nominal change in margin debt, the rate of change in that debt seems relevant. I’ll be curious if the debt has continued to fall off, when the next report is issued
Have a great week!
-Bryan
Yes, we should keep an eye out for the next margin debt report to see if the trend continues.
Interesting!
As an asset accumulator, I love stock market correction. I am waiting!
Happy Investing!
Fun fact. People who read Freedom 35 Blog are more likely to become “prodigious accumulators of wealth.” :0)
Whenever I see graphs like this I kinda scared but somewhat excited over the crash. I don’t know what I would like. A consistent bull market for next couple of years and crash or crash now and bull market for next several years. 🙂
BSR
I think it’s better if the market crashes earlier because we can use our earning powers now to buy stocks on the cheap.
Interesting but the answer is “no”, not selling my stocks 🙂
Low interest rates are like crack cocaine and we’ve been on this drug for seven years. How can you argue with the strategy of buying solid stocks that grow with inflation using borrowed money at negative real rates. Your previous post pointed out that stocks are overvalued based on historical PE ratios but what if negative real rates are here to stay. The Feds used to be proactive but are now reactive, once inflation takes hold it may be too late. 2008 showed us that buy and hold strategy only works if you can live with a 70% temporary decline and still survive your retirement, I think it only prudent to start raising cash for the next fall or maybe buy the VIX and some gold. .
I don’t know if you’ve seen interviews of Peter Schiff or James Richards recently. They are both advocates of holding at least a part of your net worth in precious metals. I happen to agree. :0) Central banks love to devalue their currencies. If it’s really a race to the bottom then I want to hold some alternative forms of wealth as insurance.
@My Own Advisor
Same here. I want to continue earning my $10,000 passive income each year.
[…] Freedom Thirty Five Blog shared some signs of a coming correction. […]
Heh heh, surprised that nobody called this yet:
You confused the cause and effect!
Balance goes negative when stock market falls. Not vise versa.
Many investors go to cash in those times, and pay off investment loan.
Good point. 🙂 I can see why investors would rush to cash if they see the markets tanking.
Response to Bram’s comment – “Balance goes negative when stock market falls. Not vise versa” Very insightful, Buying stocks reduces cash positions/increases debt and selling stocks increases cash/decrease debt, Also, when the market falls, investors are required to liquidate their leveraged positions when under capitalized. Also, as market fall, investors generally sell and vice versa. These are the reasons why markets overshoot both on the high side and the low side. Sell low and buy high is human nature and the reason why so many underperform the market. Prior to most major bear markets, the markets usually rally, enticing the novice back in on the fear that they may miss further gains only to be suckered into holding additional positions in the falling market. Timing markets are hard as even if you get it right and get out, it’s very hard to know when to get back in and the first move up is usually more violent than the moves down. One warning for everybody on this site, The buy and hold strategy has worked well especially in the last 35 years while interest rates fell from 20% to 2%, don’t expect similar returns in the future as we are… Read more »
Interesting considerations. If markets overshoot both ways then it feels like we’re on the high side right now. And I can certainly see how a large correction in the markets would be an opportunity for me since most of my money earning days are still ahead of me.
I think we’re in a bear market (and have been since summer last year, in spite of the fact as I write this S&P is actually higher). I wager it’ll continue until Q1 2017. I just wish the Fed would raise interest rates already.
Me too. Then I could finally get some better returns on my fixed income investments that pay me interest. 🙂
[…] on its own. Therefore, once it crashes, it’s going to trade closer to its value. We call this a market correction. The odds of the company going back to the price it was trading at before the crash are slim, as […]