Margin debt at the New York Stock Exchange rose to an all-time high of about $444.93 billion in December, when the S&P 500 underlying exchange-traded funds such as the SPDR S&P 500 ETF (SPY) also had a record monthly close at 1,848.36. NYSE has reported monthly data on securities market credit in three discrete series (Margin Debt, Free Credit Cash Accounts and Credit Balances in Margin Accounts) since January 2003 and on margin debt itself since January 1959.
NYSE margin debt is the aggregated dollar value of issues bought on margin (i.e., borrowed money) across the exchange. The U.S. Federal Reserve's Regulation T currently has the initial margin requirement set at 50 percent.
NYSE margin debt and the S&P 500 are highly correlated, so it is unsurprising excellent coincident or leading indicators of long-term movements in the U.S. large-capitalization index have been constructed employing NYSE data on securities market credit in general and margin debt in particular. As mentioned in "NYSE Margin Debt As An Indicator Of Long-Term Movements In S&P 500" at Seeking Alpha, my own analyses of the relevant data series historically have focused on generating two main metrics: the Margin Debt Directional Indicator and the Securities Market Credit Risk Rank.
Figure 1: NYSE Margin Debt And S&P 500 Since January 1981
Source: This chart is based on monthly margin-debt data at NYSE's online site and monthly S&P 500 data at Yahoo Finance.
I calculate the correlation between NYSE margin debt and the S&P 500's monthly closes as 0.95 during the period pictured in Figure 1 (i.e., between January 1981 and December 2014). Therefore, I consider the relationship between the two variables well established over time.
The functional nature of this relationship to me as a financial-market operator is illustrated by the following facts about the three most recent massive equity-market bubbles:
• In association with the first of these massive market bubbles, 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 other words, NYSE margin debt served as a leading indicator for the S&P 500 on the way up and a coincident indicator for the index on the way down.
• In connection with the second of these massive market bubbles, NYSE margin debt hit its high of about $381.37 billion in July 2007 and its low of about $173.30 billion in February 2009. Meanwhile, the S&P 500's monthly close peaked at 1,549.38 in October 2007 and troughed at 735.09 in February 2009. In other words, NYSE margin debt again served as a leading indicator for the S&P 500 on the way up and a coincident indicator for the index on the way down.
• In relation to the third of these massive market bubbles, neither NYSE margin debt nor the S&P 500 monthly close has necessarily hit its high or low. Given the stock market's performance to this point in January (i.e., Jan. 29), however, it appears possible margin debt and the S&P 500 may not reach record levels at the conclusion of this month.
Figure 2: Margin Debt Directional Indicator In 2013
Source: This table is based on a proprietary analysis of monthly margin-debt data at NYSE's online site.
The Margin Debt Directional Indicator is based on a comparative assessment of NYSE margin debt in the two most recent months of the data series that began in January 1959. The MDDI is pretty simple-minded even by my do-it-yourself standards, but it is amazingly useful in helping to identify major trends in the equity market.
Let's take a column-by-column look at the latest data entries in Figure 2, representing a snippet of my MDDI spreadsheet:
• Column A (Month-Year): Arranged chronologically are month-and-year data identifying the relevant periods, with the full margin-debt series currently encompassing 660 months over 55 years.
• Column B (Margin Debt M$): Most recently, NYSE reported margin debt rose to about $444.93 billion in December from about $423.70 billion in November.
• Column C (MDDI Score): When NYSE reports an increase in margin debt, I insert a positive one (1); when the exchange reports a decrease in margin debt, I insert a negative one (-1); and when it reports a flat margin-debt reading, I insert a zero (0).
• Column D (MDDI): The figure in Column C is either added to or subtracted from the previous number in Column D to produce the MDDI.
• Column E (MDDI 6M SMA): I compare the MDDI to its six-month simple moving average here. If the MDDI is higher than its six-month SMA, then I believe the stock market is in bullish mode. If the MDDI is lower than its six-month SMA, then I think the stock market is in bearish mode.
Simple-minded? Sure. Useful? You bet.
Figure 3: Highest- And Lowest-Risk Months, Per SMC Risk Rank
Source: This table is based on proprietary analyses of monthly securities-market-credit data at NYSE's online site.
December is currently No. 1 among all 131 months evaluated since the January 2003 baseline by my Securities Market Credit Risk Rank methodology. The SMC Risk Rank is based on a comparative assessment of the data NYSE has reported 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.
The SMC Risk Rank did an excellent job of preparing me for the long-term downward and upward movements of the S&P 500 between the time I began developing the indicator in mid-2007 and the end of 2012. It even did a nice job of readying me for the intermediate-term downward and upward movements of the index during its 2011 bear market, as suggested by "Thirteen Ways of Looking at Risk" at J.J.'s Risky Business.
However, the SMC Risk Rank did not behave at all well in the first half of 2013, when I believe the mechanism was engulfed by the combination of the U.S. Federal Reserve's zero-interest-rate, quantitative-easing, and other policies. I think these policies have had financial institutions awash in liquidity, some of it likely sloshing around in the form of margin debt.
Accordingly, I believe the SMC Risk Rank may soon begin performing well again, with the biggest reason embodied in the Federal Open Market Committee's decisions to taper the Fed's QE program. The FOMC announced last month it was cutting its aggregated monthly asset purchases to $75 billion in January from $85 billion in December and it said Wednesday it was trimming them to $65 billion in February from $75 billion in January.
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.