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Friday, May 8, 2015

Daily update 5/8 Margin debt

Today the market liked the employment report.  I suspect they won't like things quite as much next week. 

We started the day with a 20 point gap up in the futures.  I am sure that caught a lot of people short.  Even so there was not enough short covering to get SPX to a new high.  Breadth was a super strong +78%.  However, new highs were only 79.  SPX ended only 1 point below its closing high.  That makes that new high number worse then pitiful.  Besides the Dow the other major indexes are much further away from their highs.  That makes this still look like money moving to the biggest of the big cap stocks.  The usual defensive move for money managers that must stay invested.  SPX has been unable to stay above 2100 for long.  It will be pretty shocking to me if it manages it this time.

Despite the moonshot in price the DI lines still did not get a positive crossover.  Even the MACD is still slightly negative.  However it should cross positive on the next bar.  Needless to say this is not a strong chart technically for testing a high.  I think it will be a hard slog to truly break out.  The breadth chart backs that up.

Both the 10 DMA lines and the McClellan oscillator are still negative.  Tests of highs in this condition usually lead to a 5% or larger pullback.  I don't see any reason to believe it will be different this time.  With this long of a trading range a pullback could easily be larger then normal.  I saw this interesting stat on this extremely low volatility trading range in Contained? Dow "Range-Bound" Streak Reaches Longest Ever.
On April 24, we posted what we thought (and hoped) would be our final post concerning the stock market’s lengthy trading range. In the post we noted that for only the 8th time in 100 years, the Dow Jones Industrial Average (DJIA) had made it to 30 days without hitting either a 1-month high or low. It was, in our view, a pretty remarkable stat. Little did we know, however, that 8 days later, the streak would still be alive. And at 38 consecutive days, it is now the longest such streak in at least 100 years. The only longer streak in history occurred in 1910 and lasted 45 days (although the daily data from that era is a little sketchy so it’s possible that our current streak is the longest ever.)

That milestone alone would justify an update to the April 24 post. However, there is yet another angle to this streak that is pretty remarkable. The current 1-month range in the DJIA is a very tight 1.58%. It is so tight in fact that it accounts for the 17th narrowest 1-month range since 1990. For those scoring at home, that places it in the 0.6th percentile of all 1-month ranges. In that context, the DJIA’s record streak without a 1-month high or low is that much more amazing considering how low the bar has been for achieving a new high or low.

Today's up move turned the short term trends to neutral across the board.  A retest of the high usually goes better if the trend is already up.  With R2000 and COMPX considerably weaker then SPX it is very unlikely we are ready to explode higher.  The Dow climbed above its April high though so the streak mentioned above has ended.  It is a bit below its March high.  The SPX weekly chart now has back to back hanging man bars.  The plot thickens.

Recently there has been much discussion of margin debt in the blogosphere.  Many are trying to say it is not a problem.  Don't worry.  If I have learned anything about markets over the last 15 years is that when Wall Street pours out people saying something isn't a problem it usually is.  In the last year I have seen many articles on "new valuation methods" that show the market is not over valued.  Now they are working on the margin debt is not a problem theme.  Every major decline except the 73-74 bear market has had excessive margin debt at the top.  The crash of 87 (-35%) was actually the smallest move down with margin debt above 2% of GDP.  The others have been on the order of 50%.  It is a problem.  However, like everything else in the markets it does not matter until it matters.  Margin debt does not unwind with the market going up.  The 2000-2002 bear market was the gentlest unwind in the last 100 years.  It is usually more like 1929, 1987, and 2008.  Lets look at some charts.  Here is the latest look from Doug Short

Notice the free credit balance is much lower then even the 2000 bubble.  This backs up the comments I posted a while back from the TD Ameritrade CEO saying investors were all in.  Here is another look.

This one shows real margin debt well above the prior two bull market tops.  Notice how much more in percentage terms the debt went up over the price of SPX.  The run up into 2000 only separated near the top.  I don't know if that helped make that bear market less dramatic then other margin debt unwinds or not.  The run up into 2007 had much more separation.  The separation this time is even more dramatic. 

This an interesting article claiming margin debt is a problem and here is why.  Why Record-High Margin Debt Should Make You More Cautious  I like articles with data to back up the assertions.  Check out these charts.

Here are the real statistics: Over the past 20 years, the level of margin debt relative to the economy has had nearly an 80% negative correlation to future 3-year returns in the stock market. What this means is, the higher the level of margin debt relative to GDP, the lower the returns for the stock market over the coming 3 years and vice versa. “Statistically bogus?” I think not.

So what is the current level of margin debt suggesting for the next 3 years in stocks? Considering that margin debt-to-GDP is near an all-time record high, it forecasts returns over the coming 3 years could very well be as bad as any bear market we have witnessed over the past 20 years. Specifically, it forecasts a negative 3-year return of 50%. Maybe this is one reason Julian Robertson recently said it’s not “ridiculous” to expect another 2008-size decline in the stock market.

At some point this massive margin debt will unwind.  It is just a question of when.  I think it would take a miracle for this to unwind with less then a 40% decline.  I think it is likely to be much larger then that.  John Hussman says it is better to panic before everybody else does.  I think this is going to be a very good example of that.  I am not aware of a third bubble this close in time at any time in the past.  I think the exit is going to get extremely crowded at some point.

The market and sector status pages have been updated.  Have a great weekend.


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