By Michael Lombardi, MBA
In the midst of all the optimism we see towards key stock indices these days, there are two leading indicators that are flashing warning signals. They say, “Be careful, and don’t get caught up in the euphoria.”
Let’s start with the amount of money investors are borrowing to buy stocks…
Margin debt, the amount of money borrowed to purchase stocks, is one of the leading indicators of where key stock market indices will go. Historically, the higher margin debt gets, the more risk for key stock indices. This indicator predicted the top of the stock market in 2007 and the Tech Boom top of 2000.
As it stands, margin debt on the New York Stock Exchange (NYSE) is at its highest point ever recorded—$451 billion. (Source: New York Stock Exchange web site, last accessed March 25, 2014.) Sadly, this fact continues to be ignored by stock advisors. Yes, investors have borrowed almost half a trillion dollars to buy NYSE-listed stocks!
Another key indicator that suggests key stock indices are stretched is copper prices.
Since the beginning of the year, copper prices have plunged lower. What’s interesting about this is that copper prices usually top before the key stock market indices do; they usually bottom before stocks as well. In the chart below, I have plotted copper prices (black line) over the S&P 500 and circled areas where copper has acted as a leading indicator of key stock indices.
Copper prices topped in 2007 before key stock indices did. Then in 2009, they bottomed out well before the S&P 500, about three months earlier. Then in 2011, copper prices led key stock indices higher.
But since the beginning of 2013, copper prices and key stock indices have been significantly diverging—this is something that shouldn’t go unnoticed.
My skepticism towards the key stock indices continues to grow as I look at the indicators that suggest their direction should be down, not up. Increasing stock market optimism is dangerous.
In 2009, key stock market indices were presenting the buying opportunity of a lifetime for investors. At present, the opposite is true. The fall from Dow Jones 16,000 will be a steep one.