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Margin Debt: The Next All-Time High?


What margin debt is, and why it's so significant.

All-time highs? Yeah, we've got those.
  • In early March the Dow Jones Industrial Average (INDEXDJX:.DJI) finally snapped its early October 2007 high at 14164, and despite some subsequent choppiness, that level has held admirably.
  • The S&P 500 (INDEXSP:.INX) quickly followed suit, banishing its own October 2007 high at 1564 to the statistical dustbin in late March.
  • The Russell 2000 (INDEXRUSSELL:RUT) actually accomplished this feat in April 2011 – if only by a few points before failing to push higher – and then anticipated its large cap peers by doing it again in January 2013.
  • As for the Nasdaq (INDEXNASDAQ:.IXIC)…well, let's just say its made a good start retracing back to its March 2000 high at 5132. In fact, January marked the first time the index closed above the 50% retracement of the dot-com crash, just above 3100.
Now another measure is on the edge of printing a fresh record, one that's intimately correlated to the resolve with which these indices are pushing into uncharted territory: margin debt.

What Is It?

Toward the end of each calendar month, the New York Stock Exchange releases data on the total amount of debt carried (or "Securities Market Credit" extended) in all margin accounts at NYSE member organizations for the preceding month. Put simply: This is the total amount of money across all NYSE members borrowed by their customers to purchase securities. "Members," by the way, are firms you've no doubt heard of (Fidelity, Goldman Sachs (NYSE:GS), Citigroup (NYSE:C), BNP Paribas (EPA:BNP)) and maybe some you haven't (Battenkill Capital, anybody?).

Why Is It Significant?

Principally, margin debt is a sentiment measure. What metric could be a more direct indicator of how market participants are feeling than their demonstrated willingness to borrow money to buy stocks? The amount of debt racked up in margin accounts offers a sparingly terse, effective answer to that. This isn't a sentiment poll reliant on the mood, memory, and other subjective foibles of its respondents, but a roughly comprehensive and purely quantitative, earnest-money measure of confidence.

Similarly, margin debt equals leverage: borrowing capital to buy stocks carries a heightened capacity for reward (keep all the profits generated by the money you borrowed!) and risk (or apply a multiplier to how much you're otherwise losing). In other words, margin debt is significant because it spells out how much real money real managers of capital are willing to lay on the line, and how much they've raised the stakes on (hopefully calculated) bets they're taking.

With that brief primer out of the way, here are the NYSE margin debt figures for March published at the end of last week (the number we've been discussing is in the left-most column):

In March, margin debt clocked in at just shy of $380 billion. As for the other sometimes overlooked, but vitally important values in this table, they represent 1) the cash lying idle in non-margin ("cash") accounts and 2) the credit (as opposed to the debt we've been talking about) on hand in margin accounts. We'll look at this more in a moment, but for now, the left column is a negative; the middle and right columns are a positive. Put it all together and you have a concise picture of the aggregate market's net worth.

If $380 billion sounds like a lot of money on the line, that's because it is. In fact, in nominal terms, March 2013 is the highest margin debt figure on record, second only to July 2007. That year, margin debt peaked three months before stocks did. Since we're on the topic of all-time highs, here's that year in full:

Comparing March 2013 to July 2007, you can see a nominal record high in margin debt is a small step away.

Comparing these values and dates evokes mild alarm and some pressing questions: Is margin debt a leading indicator of major market turning points? Is this $350 billion-plus a kind of "irrational exuberance" line in the sand where the animal spirits that have been driving margin borrowing up and stock indices higher begin to cannibalize themselves and ultimately subvert the bull market they've created? What's to prevent margin debt from rising higher? And does attainment of record levels have to mean a violent downturn, or we see margin debt moderate over time unaccompanied by a major bear market? Is margin debt telling investors to expect something like late 2007 (and after) in the near-term?
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