When use of debt margin to buy stocks is at high levels, this is a signal that Mr. Market is feeling good. Risk is considered low, and investors are pumping money into the market, increasing equity values. But this is also a contrarian signal for value investors, who prefer to sell when the market is exuberant. Here's a look at margin debt use on the NYSE for the last two business cycle peaks:
From the above chart it appears that investor sentiment is highly cyclical, as margin calls appear to force reductions of debt levels when recessions hit, while investors dramatically increase debt levels when the market rises.
Despite the negativity surrounding the current market, however, January 2009 margin debt levels are still not as low as they were in the 2002 trough which followed the last recession. Furthermore, as a percentage of the S&P 500, margin levels are still rather high by historical standards:
It appears that many margin investors are still holding their investments steady, despite the grim outlook for the economy, which may suggest market confidence has not yet gone as low as it can go. It's worth noting, however, that this data is only current to January, and considering the market's steep drop in February, many margin investors may have been spooked; therefore it will be interesting to revisit this data when the February stats have been compiled.
Stay Tuned!
