Will History Repeat Itself Again--Does Margin Borrowing Peaks Indicate A Market Decline?

Reversal By Jeff Clark Tuesday, December 3, 2013

It's another new stock market record. In October, total margin debt on the New York Stock Exchange climbed to a new all-time record of $412 billion. In other words… investors have borrowed the most money ever to purchase stocks as the market hits new all-time highs. What could possibly go wrong with that? Borrowing money at low interest rates in order to invest it and earn a higher return seems like a good idea at first. After all, it feels pretty smart to borrow money at 2% interest and then make 20% returns on it in the stock market. But the stock market has a long history of humbling those who feel pretty smart… The stock market tends to form important tops right about the same time margin debt peaks. In other words, just as investors have borrowed the most money to leverage their bets in the stock market, the market starts to fall. Here's a look at the history of peak margin debt and how it lined up with tops in the stock market… Date Margin Debt Peak Stock Market Top Dec. 1972 $7.9 billion one month later Dec. 1980 $14.5 billion one month before Sept. 1987 $44 billion one month before Feb. 1994 $62 billion the same month March 2000 $278 billion the same month July 2007 $381 billion three months later In March 2000, for example, margin debt on the New York Stock Exchange climbed to more than $278 million. Then it started to fall. Later that month, the S&P 500 reached a high of over 1,520. But over the next 28 months, the index lost 45% of its value. Or take the most recent peak… In July 2007, margin debt set a new all-time high above $381 million. Then it started to fall. Three months later, the S&P 500 set a new record above 1,560. Seventeen months later, it traded as low as 667. This year, at the end of October, margin debt hit an all-time high of $412 billion. The stock market rallied to a new all-time high in November. We don't know for sure whether or not margin debt has peaked just yet. All we know right now is that history hasn't been kind to investors who pile on the leverage to buy into an expensive stock market. And history tends to repeat. Best regards and good trading, Jeff Clark