By Stephen Blumenthal, CEO, CMG Capital Management Group
Three points to think about that may help you with your portfolio positioning and risk management:
Along with the market, margin debt is at a record high – note March 2000 and July 2007 margin debt peaks.
In this next chart, margin debt is inverted. Note the high positive cash balances at the market lows in 2002 and 2009. Also note that the larger the amount of margin debt, the greater the selling pressure when margin calls kick in. This chart also shows that margin debt peaked and began to roll over about 6 months before the Aug 2000 equity market peak and about 4 months before the Oct 2007 market peak.
How I think about margin debt from a risk perspective: Margin debt fuels buying which pushes prices higher. As equity prices move higher, investors accounts have the ability to borrow/buy even more. At some point the party ends. Price decline triggers margin calls which lead to further decline and more margin calls. At market peaks, investors tend to be fully invested. It is the unwinding of margin debt caused by forced selling that helps to fuel bear market declines. Would be buyers tend to step aside. The next chart looks at the trend in margin debt. When margin debt declines below its six month moving average, major corrections in equity market prices may occur. It is not perfect but it has sound logic and a good historical track record.
It is important to note that NYSE Margin Debt is posted several weeks after the end of each month. However, margin debt peaked about 6 months before the equity market peak in 2000 and by about 4 months prior to the equity market peak in 2007. It is the unwinding of margin debt that can add to selling pressure overpowering available buying demand.
Keep your eye on a peak and subsequent decline in margin debt below its six month moving average.
Steve Blumenthal is CEO and CIO of CMG Capital Management Group. The objective behind all of Mr. Blumenthal’s work is to help advisors build better portfolios by allocating with a long term game plan that is risk sensitive and properly diversified. Mr. Blumenthal is a self-proclaimed “quant geek” with an analytical mind for the markets that helps him connect with everyday investors and industry experts alike.