{"id":42240,"date":"2013-09-22T22:49:59","date_gmt":"2013-09-23T02:49:59","guid":{"rendered":"http:\/\/countingpips.com\/forex-news\/?p=42240"},"modified":"2013-09-23T09:03:36","modified_gmt":"2013-09-23T13:03:36","slug":"the-stock-market-is-a-trap","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex-news\/2013\/09\/22\/the-stock-market-is-a-trap\/","title":{"rendered":"The Stock Market is a Trap"},"content":{"rendered":"

By MoneyMorning.com.au<\/u><\/a> <\/p>\n

What will happen if this inflatable stock market<\/strong> rally blows up? Speaking with Greg Canavan, editor of Sound Money Sound Investments<\/em>, he mentioned the idea that most of the rally in stocks<\/strong> has been ‘multiple expansion’. Earnings haven’t kept up with stock prices. Instead, investors are simply paying more for stagnant earnings.<\/p>\n

What’s more, it appears investors are paying a premium on stagnant earnings with borrowed money. Margin debt is leverage your broker allows you to use. You can borrow against the value of the securities in your portfolio to buy more securities, which works pretty well in a rising market. <\/p>\n

But in a falling market, margin calls – where you have to post more collateral against the falling value of your portfolio – accelerate stock market crashes<\/a>. To raise cash and meet the margin call, investors are forced to sell. It’s a brutal and rapid kind of deleveraging. And it’s coming to a market near you – soon, based on the two charts below.\n<\/p>\n

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\nClick to enlarge<\/em><\/a><\/div>\n<\/p>\n

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\nClick to enlarge<\/em><\/a><\/div>\n<\/p>\n

The first chart shows margin debt on the New York Stock Exchange (NYSE) going back to 1943. Below that you see that margin debt as a percentage of the total market capitalisation of the NYSE. What it shows is that margin debt is near an all-time peak in nominal terms and also near an all-time peak in terms of its percentage of market cap. Let’s break it down.<\/p>\n

The Danger of Borrowed Money in Today’s Financial System <\/h2>\n<\/p>\n

In March of 2000, margin debt peaked at a then-all-time-high of $278 billion. That was a peak in its percentage of market cap, and quite obviously it was a peak in the stock market<\/strong>, which proceeded to crash over the next three years. Only Alan Greenspan cutting interest rates 13 times in a row and leaving them at one percent for twelve months reversed the decline.<\/p>\n

In June of 2007, margin debt on the NYSE made a new all-time-high at $378 billion. That was around the time the Bear Stearns leveraged mortgage funds began to crack. It was an early warning sign of the big credit crisis. That crisis destroyed the value of collateral in the banking system and led to a lot of forced selling of stocks. Hence the stock market high.<\/p>\n

Australian stocks have just now recovered from the fall from the 2007 peak. In fact, as I write the All Ords are trading at 5276. The last time they traded that high was August 2008. They fell by 40% over the next eight months, before bottoming at 3111 in March of 2009.<\/p>\n

And now here we are, looking at the second chart. The growth in margin debt has clearly fuelled the rise to all-time highs on the S&P 500. The rotation out of fixed income and emerging market stocks has poured even more fuel on the fire. At $382 billion dollars, margin debt is peaking along with stocks<\/a>.<\/p>\n

The boom in margin debt is a feature of Ben Bernanke’s attempt to levitate asset markets across a sea of bad debts in the financial system<\/a>. The trouble is, there is nothing on the other side. In stock market cycles, shares move from overvalued to undervalued. They are over-bought and over-valued now.<\/p>\n

Could they go higher still? You bet they could. If margin debt as a percentage of market cap reaches a new all-time high, there’s probably another 5-10% rally in store. That’s the sort of move that could happen if the Federal Reserve<\/a> taper worries prove to be unfounded…and if the prospect of war in Syria fades. That’s a powerful cocktail for higher prices.<\/p>\n

But the numbers don’t lie. When people borrow money to bet on higher prices, you’ve reached the end of a cycle. Sentiment and recklessness peak. The trade gets crowded. And then it reverses.<\/p>\n

Dan Denning+<\/a><\/strong>
\n Editor, The Denning Report <\/em><\/strong><\/strong><\/p>\n<\/p>\n

Join Money Morning on Google+ <\/u><\/a><\/strong>
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\n<\/img><\/a> <\/img><\/a> <\/img><\/a>\n<\/div>\n

<\/p>\n","protected":false},"excerpt":{"rendered":"

By MoneyMorning.com.au What will happen if this inflatable stock market rally blows up? Speaking with Greg Canavan, editor of Sound Money Sound Investments, he mentioned the idea that most of the rally in stocks has been ‘multiple expansion’. Earnings haven’t kept up with stock prices. Instead, investors are simply paying more for stagnant earnings. What’s … <\/p>\n

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