Are Historical Highs in Margin Debt In a Low Growth Environment Equal Deja Vu?

by on November 30, 2013 8:52 am GMT

Equities keep going up and have been over the years, increasingly, regardless of the warning signs. Investors and traders have a win-win attitude when not even poor economic data can cause a correction in risk assets, which have reached historical highs. The S&P index is up eight weeks in a row and have made 13 “new” highs this year, up 32 percent. The DOW has made 40 “new” highs this year.

For instance, over the last year (while equities hit all-time highs) the United States has missed eight of the last 12 quarterly gross-domestic product prints, with only one hitting three percent. Investors continue to make the case that the United States is growing, but if one look’s the the trend, there is not much growth. The quarterly average is a mere 1.8 percent.



Another striking data point is the record margin debt taken on by investors. Margin debt is capital market participants borrow in order to buy assets, and the amount is shocking. $412.5 billion has been borrowed on the New York Stock Exchange, which is a 13.2 percent increase year-to-date and a 50 percent increase year-over-year.

Market participants are so sure of the market will continue to go up that they are willing to take on debt to buy more assets at record levels.

Leverage is a double edge sword. When the market becomes unstable and cracks, 20 point declines on the S&P will become daily events. “When the tablecloth gets pulled out from under the place settings, you’re going to have a lot of them crash and smash on the floor,” said Uri Landesman, president of Platinum Partners hedge fund.

The financial markets, and those that play them, have very short-term memories. Just five years ago the threat of margin calls caused one of the worst meltdowns in history. It also begin with a bull market supported by leveraged buying.

Let’s put it this way – there has been two other occurrences margin debt hit close to current levels. The first time being in 1999 just prior to the tech bubble crash, the other in 2007 right before the financial meltdown. 

Historical Margin Debt.

Historical Margin Debt.

According to Dealogic, leveraged lending, which could involve little to no collateral, reached $969 billion in 2013. This only falls short to 2007 levels, and leverage lending is up 29 percent year-over-year.

It is no secret that the markets are higher due to central bank liquidity and not much more. And those that say it’s not are full of it. When world growth expectations hit all-time lows and world equity prices hit all-time highs, there is something wrong.

Global Equity Prices at All-Time Highs, Global Growth at All-Time Lows

Global Equity Prices at All-Time Highs, Global Growth at All-Time Lows

Take a look at what the Federal Reserve has achieved since the first quantitative easing program in 2009. The figures speak for themselves, and there has been nothing but diminishing returns since QE2. Real GDP has actually gone down. So much for those analysts on CNBC and Bloomberg saying America is heading in the right place.

Economy Since QE1

Economy Since QE1

There are less market bears in the market then any time in… forever, it seems. A bearish sentiment indicator (dating back to 1989) by Investors Intelligence shows only 15 percent of investors are bears. What happens when there is no one left to sell to?

Bear Sentiment by Investor's Intelligence.

Bear Sentiment by Investor’s Intelligence.

There is no doubt that equities will go up for the mean time, but that is by no means a reason to buy hand over fist (let alone go into debt doing so). The point, I hope, this piece portrays is that there is a massive divergence from risk assets and growth. And sooner than later, there will be mean reversion and deep corrections in risk assets. Sooner or later the Fed will have to taper. Corrections will be swift, gory and continue to show that greed will always overwhelm then destroy the financial markets.