Stock Market Danger Signals – Margin Debt

You may not realize this, but lots and lots of investors go into debt to invest in the stock market – especially small investors. Small investors are generally very emotional investors. They get swept up with the ‘thundering herd’. If it looks like everybody is investing in Farm Tractor stocks, they go and invest in Farm Tractor stocks. If everyone is investing in Moon Exploration stocks, they jump in and buy with the ‘thundering herd’. And, they tend to jump in with both feet and lots and lots of margin debt. So, you know when the ‘small investor’ is getting excited, when you see margin debts climb skyward.

The problem is that small investors always seem to buy into the stock market just as it’s about to crash. That’s why a rapid increase in margin debt is a very, very bad sign. And what do you think that we are seeing right now?

Yeah. Margin debt levels are approaching what we last saw in 2007, just before everything fell apart.

Here’s a scary chart:

NYSE Margin Debt and S&P 500
NYSE Margin Debt and S&P 500

The above chart comes from Doug Short, from his article, NYSE Margin Debt: April Still Looks Like a Cyclical Peak.

Did you notice the blue line?

That’s the stock market. When margin debt peaks, stock markets peak.

Did you notice the grey area?

That’s very bad news. Those grey areas are recessions, and they follow market crashes.

Here’s another look at this from a different angle:

NYSE Investor Credit and the Market
NYSE Investor Credit and the Market

Notice that the negative credit balances have shot beyond the June 2007 highs. This is not good – very, very not good.

All that it will take to ‘pull the plug’ on this market will be for big investors to pull their money out, which would leave the small investor swinging in the wind. And, it looks to me like that’s what happened twice in the above chart.

For a long time, the US stock market has been transferring wealth from the small investor to the large one. And, I think that we are going to see another big wealth transfer soon. This is NOT a good time to be in stocks.

We’ll see what happens in September and October. Rough waters ahead.

To read what Doug Short has to say, go here:

http://advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-the-SPX.php

And then, there’s the irrepressible Max Keiser. Watch as he and Stacy talk about margin debt and the small investor:

(Max loves to play the clown, but he is very, very smart. Pay attention to this guy. – jl)

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