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Excellent coincident or leading indicators of long-term movements in the U.S. large-capitalization index underlying exchange-traded funds such as the SPDR S&P 500 ETF (NYSEARCA:SPY) during the three massive equity-market bubbles of the 21st century have been built on New York Stock Exchange (NYSE) data on securities market credit in general and margin debt in particular. My own analyses of the relevant data series reported each month by NYSE historically have focused on generating two main indicators: the Margin Debt Directional Indicator and the Securities Market Credit Risk Rank.

The Margin Debt Directional Indicator is founded on a comparative assessment of NYSE margin debt in the two most recent months of the data series that began in January 1959. For example, the exchange reported margin debt ballooned to about $423.70 billion in November from about $412.60 billion in October. This expansion suggests the current stock-market bubble was still being inflated as of last Nov. 30, which is consistent with the S&P 500's subsequent behavior in December when it rose on a closing basis to 1,848.36 from 1,805.81, a swelling of 42.55 points, or 2.36 percent.

The Securities Market Credit Risk Rank (SMC Risk Rank) is founded on a comparative assessment of the data NYSE has reported since January 2003 in three discrete series: Margin Debt, Free Credit Cash Accounts and Credit Balances in Margin Accounts. This dynamic indicator is designed as a measure of equity-market risk, ranking each month in the series on an ongoing basis. A high SMC Risk Rank for a given month suggests the stock market may be close to a significant peak and a low SMC Risk Rank for a given month suggests the stock market may be close to a significant trough. In my interpretation, the term close in this context typically has meant within three to six months.

Figure 1: Margin Debt, S&P 500 Levels Since January 1959

(click to enlarge)

Source: This chart is based on monthly margin-debt data at NYSE's online site and monthly S&P 500 data at Yahoo Finance.

Both NYSE margin debt and the S&P 500 appear to have behaved one highly correlated way before the Age of Voodoo Economics dawned circa January 1981 and another highly correlated way thereafter.

In assigning responsibility to American presidents for their precursor roles in creating current economic and financial-market conditions, some analysts blame or credit Richard Nixon for banning the convertibility of the U.S. dollar into gold in 1971, and some analysts blame or credit Jimmy Carter for accelerating the deregulation of industry in 1978.

Based on NYSE margin-debt and S&P 500 data, however, Ronald Reagan's fiscal policy seems to have led to a clearer demarcation in the financial markets than did either of the other two initiatives. Of course, one could argue all three had cumulative and synergistic effects over time, which is likely the case to a certain degree.

Figure 2: Margin Debt, S&P 500 Levels Since January 1981

(click to enlarge)

Source: This chart is based on monthly margin-debt data at NYSE's online site and monthly S&P 500 data at Yahoo Finance.

In association with the first massive equity-market bubble of the 21st century, NYSE margin debt hit its high of about $278.53 billion in March 2000 and its low of about $130.21 billion in September 2002. Meanwhile, the S&P 500's monthly close peaked at 1,517.68 in August 2000 and troughed at 815.28 in September 2002.

In connection with the second massive stock-market bubble of the 21st century, NYSE margin debt hit its high of about $381.37 billion in July 2007 and its low of about $173.30 billion in February 2009. Meanwhile, the S&P 500's monthly close peaked at 1,549.38 in October 2007 and troughed at 735.09 in February 2009.

In relation to the third massive market bubble of the 21st century, neither NYSE margin debt nor the S&P 500 has necessarily hit its high or low (obviously). Given the market's performance in December, it appears highly probable margin debt reached another record level last month.

However, Stein's Law presumably will come into play at one point or another. As formulated and recapitulated at Slate by Herbert Stein, once famed as the chairman of the Council of Economic Advisers between 1972 and 1974 and now renowned as the father of author, attorney and actor Ben Stein ("Bueller? Bueller?"), this law states, "If something cannot go on forever, it will stop." Because I believe the expansion of NYSE margin debt in association with the current market bubble cannot go on forever, I think it is wise for me as a market participant to develop fact-based opinions about when and where it will stop. (And, of course, I have.)

Figure 3: Highest, Lowest Risk Months, Per SMC Risk Rank

(click to enlarge)

Source: This table is based on proprietary analyses of monthly securities-market-credit data at NYSE's online site.

The Securities Market Credit Risk Rank did an excellent job of preparing me for the long-term downward and upward movements of the S&P 500 during the first five-and-one-half years of its existence, as suggested not only by Figure 3 but also by "Thirteen Ways of Looking at Risk" at J.J.'s Risky Business. However, it did not perform at all well in the first half of last year. Why? I suspect the indicator was engulfed by the combination of the U.S. Federal Reserve's zero-interest-rate, quantitative-easing, and other policies, which together have financial institutions awash in liquidity, some of it probably sloshing around in the form of margin debt.

If my suspicion proves to be well founded, then the SMC Risk Rank may soon begin delivering on its promise again, with the biggest reason being the Federal Open Market Committee's decision to start tapering its QE program by cutting its aggregated monthly asset purchases to $75 billion in January from $85 billion in December.

Questioned about the likely course of the QE program at an FOMC press conference on Dec. 18, Fed Chairman Ben S. Bernanke answered:

"[T]he steps that we take will be data-dependent. If we're making progress in terms of inflation and continued job gains - and I imagine we'll continue to do, probably at each meeting, a measured reduction - that would take us to late in the year ... If the economy slows for some reason or we are disappointed in the outcomes, we could skip a meeting or two. On the other side, if things really pick up, then of course we could go a bit faster, but my expectation is for similar moderate steps going forward throughout most of 2014."

As a result, I will be paying extra attention to my Margin Debt Directional Indicator and SMC Risk Rank this year.

Disclaimer: The opinions expressed herein by the author do not constitute an investment recommendation, and they are unsuitable for employment in the making of investment decisions. The opinions expressed herein address only certain aspects of potential investment in any securities and cannot substitute for comprehensive investment analysis. The opinions expressed herein are based on an incomplete set of information, illustrative in nature, and limited in scope. In addition, the opinions expressed herein reflect the author's best judgment as of the date of publication, and they are subject to change without notice.

Source: NYSE Margin Debt As An Indicator Of Long-Term Movements In S&P 500