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. 😕
Random Useless Fact:
Tadpoles breathe through gills, much like fish. They eventually lose their gills as they grow and turn into frogs or toads.