Traders combing the evidence for signs of a trend change in stocks should take a hard look at NYSE margin balances. The amount of customer borrowing at brokerages to buy stocks is traditionally seen as a sentiment indicator: The higher the borrowing on margin, the less buying power remains. A high balance also indicates that buyers are bullish enough to borrow to buy, and this is often a warning that the market can reverse course. Too many bulls can tip the market in the other direction. But margin borrowing can give us other information as well.
Margin balances are certainly elevated at $267 billion. We've averaged about $200 billion over the past 15 years. They've been higher--they peaked in July 2007 at $381 billion, and hit $278 billion in 2000--but they're high enough to warrant caution. (Note that stock prices peaked the same month margin balances hit their high in 2000, and three months after margin balances peaked in 2007.) However, the simple level of margin balances alone is not very helpful in terms of timing.
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Margin balances can be useful in another way, and right now it is this additional signal that is of particular interest. The amount of margin borrowing closely tracks the moves of the stock market, as you can see in the chart above. The white line represents the price of the S&P 500, while margin borrowing is depicted in yellow. Margin balances are a coincident indicator. They neither lead nor lag the stock market.
Like many coincident indicators, it gets interesting when the indicator diverges from the market, and as you can see, we have a rare divergence right now. Stocks have continued to rise while margin balances have turned down. Take a look at what happened the first two times these series diverged. In both cases, the market came down to meet the margin balances, not the other way around.
The longer term chart (below) illlustrates how rare this divergence is. Going back more than 15 years, this kind of separation has been very rare. The chart also shows that the strong relationship between stock prices and margin balances goes back a very long way.
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Unlike the overall level of margin borrowing, it is not clear why this divergence would affect the market in one way or the other. My own interpretation is that the drop in margin balances represents investor deleveraging, and this deleveraging coincides with a more generalized sale of stock. At any rate, the relationship between the two is strong enough to monitor, especially given that the two have recently gone their separate ways.
Margin balances are reported around the 20th of the month, so we have about three weeks to wait before we can see which way the yellow line will move. But we won't have to wait that long to see what happens to stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.