Saturday, January 17, 2009

Deleveraging and Stock Market Margin Debt

Margin debt for NYSE stocks (above) is an excellent measure of investor sentiment, as it captures risk-seeking vs. risk-aversion in the stock market. Margin debt tends to expand in bull markets and contract during bear moves. Indeed, you could say that we have bull and bear markets to the degree that investors are willing to assume or unwind leverage.

In this period of deleveraging, margin debt has fallen precipitously as the chart above shows. We're now running the same level of margin debt as we had early in 2001. Nor is there any sign to date that the unwinding of leverage is moderating.

Going back to the start of my data series on margin debt (1944), we find that the 20-week average change is the weakest that it has ever been. Specifically, margin debt has been down by over 42% in the last 20 weeks. The nearest we've come to such unwinding of margin has been a 31% drop in 1946 and 29% drops in 2001 and 1988.

It is tempting to speculate that we might be near a bottom, given the historic flushing out of market bulls. My take on the data, however, is more cautious. This is looking like a deleveraging that is qualitatively different from bear markets of the post World War II period. It is difficult to see evidence of risk appetite among individual investors, and I am not detecting any great rush into equities from institutions. Indeed, the recent weakness among banking stocks suggests that, for all the alphabet soup of rescue programs, we continue to focus more on vulnerabilities in the economic system than potentials.

Until we see some moderation in the decline in margin debt numbers, as occurred late in 2002 and early in 2003, it is probably premature to assume that bear market bounces are fresh bull markets.