Wed. Oct 27th, 2021

CHAPEL HILL, NC – A surprise drop in margin debt last month – what investors have lent to buy stocks – does not mark the end of the bullish market.

Of course, a bear market could start at any time, but if it does, it will be for other reasons.

FINRA reported last week that total margin debt contracted by 4.3% in July, the first monthly decline in 15 months. While some see this fall as a harbinger of a new bear market, historical data does not support their concern.

This is because margin debt is not a leading indicator of the stock market. It gives us no idea of ​​the market trend that we could no longer get simply by focusing on a chart of the S&P 500 SPX,
+ 0.13%
or another broad market average.

In contrast, margin debt is a coincident indicator, which increases when stocks rise and falls when the market declines. I documented this by analyzing the relationship since 1970 between the 12-month rate of change in margin debt and that of the S&P 500 adjusted for dividend and inflation. The square r of this correlation is an impressive 47%. This means that the rotations of the S&P 500 account for 47% of contemporary changes in margin debt.

But I was left speechless when I used the 12-month rate of change in margin debt to predict the profitability of the S&P 500 for the next twelve months. In this case there was no statistically significant correlation. The same thing happened when I used the one-month rate of change in margin debt to predict subsequent yields on the S&P 500.

There’s another reason not to read too much about the fall in margin debt in July: when margin debts are offset by free credit balances in investors ’margin and cash accounts, the July figures are totally exceptional.

I have the idea to focus on this net number of Lance Roberts, chief investment strategist at RIA Advisors, and the accompanying chart represents him. As you can see, balanced investors have been getting into more and more debt for many years. The July total, which is the most accurate data point on the chart, is simply a continuation of the trend.

In an interview, Roberts argued that margin debt, either by itself or offset by investors ’free credit balances, is not in itself a problem. It only becomes one during the market crash, when the decline may worsen. In other words, it increases market risk. But the spark that ignites this decline will be something other than the margin, he says.

I also have a more cynical reason to question the bears’ argument that the fall in the margin in July heralds a new bear market: this spring, when margin debt had been rising for many months in a row, some argued that the debt of growing margin was bearish. They were wrong, of course, for all the reasons discussed here. But if the bones are consistent, they cannot argue that both the ascending and descending margins are bearish.

In fact, however, margin debt trends are neither upward nor downward. So, if you want to worry, look for something more than margin debt.

Mark Hulbert regularly contributes to MarketWatch. His Hulbert Ratings keeps track of investment bulletins that pay a fixed fee to be audited. You can contact him at [email protected].

Now read: The S&P 500 has not fallen at least 5% in nearly 200 sessions; that’s what the story says

Sometimes we include links to online retail stores. If you click on one and make a purchase we may receive a small commission.

Source link

Leave a Reply