With stocks (SPY) up more than 150% from the March '09 bottom, it's not surprising that people are looking for reasons for the market to pull back a little. Making matters worse is the move we've seen since the fall of 2012, in which the S&P has ascended about 22% without a meaningful pullback.
So that means we're in a bubble, right? We must be, especially considering the fact that the Fed has pegged interest rates at zero for such a long time. This is how bubbles are created.
Well, that's certainly been a common thought process throughout the course of this economic recovery (which many people are still fighting, amazingly). Now people are starting to buzz about the record margin debt we're seeing, which is supposed to be reflective of the growing bubble in asset prices (chart courtesy of SA author The Financial Lexicon):
What's clear about this chart is that margin debt peaks when stocks peak. So with margin debt breaking the old high of $380 billion, the thought seems to be that we must be nearing a peak in equity values, or at least creating a bubble in them.
In reality, all this chart illustrates is the correlation between debt and the value of the collateral (stocks) put up to take on that debt (margin). As the value of your collateral increases, you can take on more debt. We do that with everything: our government takes on more debt as we grow (imagine having $17 trillion in debt in 1945), we use our homes as collateral for bank loans etc.
Of course, this can get us into plenty of trouble. Using your home as a "piggy bank" generally doesn't end well, and we've seen our government running deficits well above the customary (and sustainable) 2-3% of GDP. But the collateral system does work pretty well, and our credit based economy relies on people being able to put their assets up for sale so they can expand their businesses, or put their kids through college (please spare everyone your commentary on why our credit-based economy is going to collapse). If and when the money that was used to buy capital (applicable to both physical and intellectual capital) earns an appropriate return on capital, the money gets paid back and everyone is better off.
Back to margin debt. It makes perfect sense that as the value of stocks has risen, investors have taken on more margin. It's all relative.
When the market peaked in 2007, the cumulative market capitalization of the S&P 500 was $13.8 trillion, and NYSE margin debt was $381 billion. That means that margin debt as a percentage of market cap was 2.76%.
Today, with the total market cap of the S&P 500 at approximately $15 trillion, and margin debt at $384 billion, the percentage is 2.56%.
With free cash balances in these accounts essentially at the same level, margin accounts are actually less leveraged than they were in 2007. In the context of record-low interest rates, which provide an extremely attractive cost of capital, I'm actually surprised the percentage isn't higher today.
Now, I'm not saying we haven't gotten a bit too bullish recently. We've seen the stories of hedge funds chasing returns via OTM (out of the money) call options on the SPY, and we've seen the headlines in the papers. People have caught on to the bull market in stocks. Stocks are obviously not the bargain they were in 2009, but I think we've got some upside left. Cyclicals like Ford (F) look significantly undervalued, and a steepening yield curve will be a big net positive for insurers like Aflac (AFL) and the money-center banks like Wells Fargo (WFC) and Citigroup (C).
Regardless of where you think we're headed, concerning yourself with today's record margin debt levels isn't a very helpful strategy.
For further reading and an alternative margin debt to stocks chart, click here.