Increased margin debt: bullish or bearish?
Margin debt shot up in May
By Mark Hulbert, CBS.MarketWatch.com
Last Update: 12:01 AM ET July 8, 2003
ANNANDALE, Va. (CBS.MW) -- Pencils ready?
Here's today's investor pop quiz: Is it bullish or bearish that total margin debt in May had its biggest one-month increase since the top of the Internet bubble in early 2000?
While you're mulling over your answer, let me review for you how total margin debt is calculated.
At the end of each month, the NYSE gathers from all member firms the total amount that those firms' customers have borrowed in order to purchase securities. The NYSE sums all these amounts and reports the total around the middle of the following month.
May therefore is the most recent month for which the NYSE has compiled this data. As of the end of that month, total margin debt amounted to $146.4 billion, representing a 7.7 percent increase over the $135.9 billion total for the end of April. The last month before May in which margin debt grew at this fast a pace was February 2000, in which month it grew 8.9 percent.
Some contrarians think this parallel to early 2000 bodes ill for the current stock market. Over this past weekend, for example, Allan Harris of the No-Load Navigator newsletter wrote that May's big increase is evidence of "how dangerous the market is right now."
But Norman Fosback of Fosback's Fund Forecaster disagrees. Fosback, who has analyzed trends in margin debt back to 1942, has found that while traders who buy stock on margin tend to be wrong at market turning points, they often are right on the money during the long periods of time in between those turning points.
In other words, the contrarian perspective on margin debt is helpful only a small minority of the time.
In his 1974 investment textbook, "Stock Market Logic," Fosback reported that the best way to use margin debt statistics is to compare the current total to an average over the previous 12 months. "If the current level... is above the 12-month average, the series is deemed to be in an uptrend, margin traders are buying, and stock prices should continue upward."
"By the same line of reason, sell signals are rendered when the current monthly reading is below the 12-month average. This is evidence of stock liquidation by margin traders, a phenomenon which usually spurs prices downward."
In 1974 Fosback reported impressive results from backtesting this market-timing indicator. And it has definitely acquitted itself well during the 2000-2003 bear market. Total margin debt hit its peak in March 2000, and fell below its 12-month moving average several months later. It has been below that moving average for most of the time since then.
Until now. With May's big increase, total margin debt is now well above its 12-month moving average.
And that is definitely bullish, according to Fosback's analysis: "When the current level of margin debt is above its 12-month moving average, bull market probabilities exceed 85 percent."
Is that how you answered your pop quiz?
Even if you did, however, Fosback cautions you not to get carried away. The short and intermediate trends may be bullish, but the market's longer-term prospects are "anemic" at best. That's because the market's fundamentals are "atrocious."
On Fosback's analysis, therefore, the stock market's shorter-term potential is brighter than its longer-term prospects. |
