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Friday, April 19, 2013

Margin debt problem revisited

I have talked about the margin debt problem several times since last fall.  Here is a refresher of the long term history.


Something I did not notice before.  Even though the Dow made a lower low then in 2002, the margin debt made a higher low.  If that 2009 low was truly a generational low as many people proclaim I think the margin debt should have been much lower.  The fact that it was higher then in 2002 strongly suggests people did not throw in the towel on stocks as the pundits would like us to believe.  At the final low of this secular bear market there will be a throwing in of the towel, get me out at any price move.  Even though it may have looked like we had that, I don't think that was the case.

I found an interesting chart that looks at margin accounts slightly differently.   Here is what they calculated.

Let’s look at the data another way, focusing on the Net Worth of Margin Accounts. Net worth is calculated by taking the (Free Credit Cash accounts + Credit Balances in Margin Accounts) and subtracting this figure by the overall Margin Debt. At present, Margin accounts have a negative net position.
Again we see a graphic that suggests, at least based upon historical precedent, that when the Net Worth of Margin Accounts is negative, equity prices have struggled to continue their move higher.


I added the blue lines at the points where the net worth line bottomed out and turned up.  In the prior two instances of going negative the market peaked around the time the net worth turned up.  Currently it appears to have turned up again.  Whether we sell off and retest this high I cannot say for sure, but I believe that a retest would fail.  I don't think the market is going to break out and race higher from this condition.  With the global economy most likely in a recession the downside risk is high.


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