Jeff Cooper: Are Margin Debt Levels Pointing to a Peak in the S&P 500?
Is one of the reasons why risk continues to be skewed to the upside because the investment community has a Sherpa called the Federal Reserve Bank?
Life is not always a matter of holding good cards, but sometimes, playing a poor hand well.
-- Jack London
Gentleman, keep in mind that the cards you hold in your hands are nothing but dumb luck. The difference between winning and losing is being able to read your opponent.
-- Suicide Kings
The poker player learns that sometimes both science and common sense are wrong; that the bumblebee can fly; that, perhaps, one should never trust an expert; that there are more things in Heaven and Earth than are dreamt of by those with an academic bent.
-- David Mamet
Twice a silly price is not twice as silly; it's still just silly.
-- David Einhorn
David Einhorn is a brilliant investor and a good poker player who said 15 years ago that there is a stock bubble.
Bubbles are like poker: All the cards aren't shown until the money is up. Even then, you don't always get to know how much bluffing drove the game.
It's only at the end of both games that people learn that sometimes, twice a silly price may actually be twice as silly.
Stocks have a way of growing bigger ever so slowly over time that they disabuse the vast majority that they will burst and that they instead can just bluff their way higher into self-sustaining vapors.
The thing is that bubbles aren't necessarily just about valuations, just as a poker tournament isn't about the smartest person in the room. There can be bubbles in psychology, in the allure of expectations. In other words, if there is a bubble, since people are calling it a bubble, it's probably not one; and even if it is one, it's probably only a tiny bubble. And, since everyone knows that bubbles expand and no one knows how big they can get, and that the most money is made during the last stages of advances, performance considerations dictate that one must ride the trend until it warns of trouble and offers a graceful exit.
The slow-motion train wreck in 2008 offered a graceful exit. How many took it?
The market usually, but not always, offers a graceful exit. The problem is that time-lapse train wrecks aren't recognized for what they are until it's too late. Like bubbles?
We hear that the market is under-loved by the public, so this can't be a bubble. Perhaps the question should be this: Does a top that augurs in the arrival of a bear market have to be accompanied by a bubble?
The market is not under-loved by the professionals now, whereas in 2000 many pros didn't understand what was going on.
The point is that the public has been so traumatized by the stock market over the last decade that it is anyone's guess when it will return to the market. If the public hasn't jumped back into stocks when faced with virtually zero return in bonds, what does that say about its distrust of Wall Street?
If the public is investing, it probably doesn't trust itself and is allocating funds to money managers and mutual funds.
Some make the point that the leverage among the public today is low and inconsistent with that of dangerous levels of leverage that blow bubbles -- the thinking being that since the public is not highly leveraged, there is little risk of a debacle spearheaded by margin because leverage among professionals with staying power is not alarming. That's like saying the amount of US debt is not a threat because the government has staying power and knows what it's doing.
The point is that there is beaucoup leverage today, and it is among the professionals and corporations. Clearly, the chart below sent from a fellow trader around a week ago shows that someone is on margin.
Click to enlarge
My friend, a fellow trader, made an important point: "Given the market has shown distribution over recent weeks, we should keep watch for a change in direction of margin balances. A significant drop would be confirmation that a top may be in for the year."
Let's take a look at margin debt as a percentage of US GDP.
No bubble here, right?
Lance Roberts of StreetTalk Advisors analyzed margin debt in a larger context that includes free-cash accounts and credit balances in margin accounts. Essentially, he calculates the credit balance as the sum of free credit cash accounts and credit balances in margin accounts minus margin debt. The chart below illustrates the mathematics of this credit-balance calculation with an overlay of the S&P 500 (INDEXSP:.INX). The chart below is based on nominal data and is not adjusted for inflation.
Click to enlarge
I can't help but think that one of the reasons why risk continues to be skewed to the upside in the US equity market in spite of the mountain of debt shown above is that the investment community has a Sherpa called the Federal Reserve Bank.
Maybe the real bubble is the bubble in belief in the Fed. If so, it's a doozy that's been blowing for a hundred years. Other than the fact that the Fed's mandate has been to protect the value of the dollar, to prevent panics, and to promote employment, it has done a swell job -- not to mention that pesky affair in the 1930s when the Fed froze like a deer in headlights.
Basically, to paraphrase one pundit, if the Fed's current policies work, there will never be another economic downturn. The Fed has discovered the magic economic elixir. It's easy to be bullish if you believe there is no "it" out there -- that there are no consequences to the Fed's unprecedented actions.
I think this could be the real bubble: the belief in the Fed put -- the belief that the Fed can unwind its actions of the last six years and, as my fellow trader says, "land the unicorn on a postage stamp on the Hudson."
Can Apple's (NASDAQ:AAPL) big beat after the close power the S&P to a new high into May? Can Apple's financial wizardry replace product wizardry? Apple will issue bonds to fund dividends and buybacks. Its five-year bonds currently yield less than its stock's dividend.
After the bell yesterday, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) exploded on the heels of Apple's and Facebook's (NASDAQ:FB) beats. If the S&P is able to set a new high above 1,900 into May, technically it may be hard to sustain. As you know, a new high would satisfy a three- to four-month Broadening Top. A run toward prior highs could also see a test of the early April Key Reversal. A test failure of the large-range reversal from April 4 would be the normal expectation on the first time up and could indicate a double top. Of course, follow-through offsetting the Key Reversal Day would be bullish, but can the abrupt rotation into large caps at the expense of smaller caps see the market maintain its equilibrium?
Interestingly, as the S&P and the SPY test all-time highs, strength today and tomorrow could see the Nasdaq-100 (INDEXNASDAQ:NDX) test critical resistance. Two declining trendlines on the NDX cluster at 3,600 as resistance
Following six straight days of gains, the major indices pulled back on Wednesday (April 23). Note that the NDX turned its Daily Swing Chart down on Wednesday in tandem with a backtest of its underlying 20-day moving average coinciding with Gapfill.
Did the NDX carve out another "V" Bottom leaving what I call a "Flamingo Low"? A Flamingo Low consists of two spike reversal lows that leave a double bottom, in this case the February and April bottoms. Or, bearishly, will the a test of 3,600 leave the NDX staring into the abyss below 3,400?
Yesterday [subscription required], I walked through the playbook for a continuation of the rally into early May. Interestingly, 361 (for 3,610 NDX) is a corner number on the Square of 9 Chart that is straight across and opposite early May. For the bears, 3,400 looms large if they can claw at NDX as it tests a well-tested declining trendline contained by a backtest of its overhead 50 DMA.
Moreover, a possible double top or Broadening Top on the S&P and a lower high on the NDX will occur as momentum carves out a potentially bearish picture.
Momentum has retraced to a declining trendline and shows a possible right shoulder of a Head & Shoulders top in 2014. Notably, the right shoulder could play out below the 50 DMA.
Additionally, the Consumer Discretionary SPDR ETF(NYSEARCA:XLY) is showing its most persistent weakness relative to the S&P 500 since the spring of 2009.
Following a double top, XLY shows a double bottom at the level of last summer's highs. At the same time, it has snapped a multi-year trend line. If the recent double bottoms break, XLY will be left in a weak position, vulnerable to a violation of a Live Angle at 60 and confirming a contraction in the consumer discretionary sector. Importantly, persistent relative weakness in the XLY foreshadowed the 2000 and 2007 market tops.
Every pullback low since November of 2012 has been followed by a march to new highs. Are the first four months of 2014 distribution or consolidation walking off the persistent rally in 2013? The market has done a good job teaching players to dance with fear. But fear is not the enemy. Like in poker, paralysis is the enemy. It will be interesting to see who blinks first as the indices face resistance.
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