There has been much written as of late about the continued surges in margin debt. This was particularly the case when margin debt increased in January even as the markets declined. My friend Doug Short recently penned his monthly update on margin debt stating:
“The latest data puts margin debt at an all-time high, not only in nominal terms but also in real (inflation-adjusted) dollars. Here’s a slightly closer look at the data, starting with 1995. Also, I’ve inverted the S&P 500 monthly closes and used markers to pinpoint the monthly close values.”Â
“As I pointed out above, the NYSE margin debt data is several weeks old when it is published. Thus, even though it may in theory be a leading indicator, a major shift in margin debt isn’t immediately evident. Nevertheless, we see that the troughs in the monthly net credit balance preceded peaks in the monthly S&P 500 closes by six months in 2000 and four months in 2007. The most recent S&P 500 correction greater than 10% was the 19.39% selloff in 2011 from April 29th to October 3rd. Investor Credit hit a negative extreme in March 2011.”
Doug also correctly comments that:
“There are too few peak/trough episodes in ithis overlay series to take the latest credit-balance trough as a definitive warning for U.S. equities. But we’ll want to keep an eye on this metric in the months ahead.”
I too have previously discussed the rising levels of margin debt from this perspective. Therefore, in an attempt to answer these questions, we need to do two things:
1) Use a full set of margin data going back to 1959, and;
2) Apply technical analysis to the underlying data to determine if the momentum of increases in margin debt is reaching levels historically indicative of corrections in the markets.
For the second step, I will use two technical indicators:  Stochastic Oscillator and Relative Strength Index. If you are unfamiliar with these indicators, here is a description of each viaStockCharts:
