NYSE Margin Debt Stalks All-Time Highs

Here’s an interesting bit of correlation (and causation?) for you.  Have a look at the chart I formulated below showing NYSE Margin Debt and the S&P 500.  The two data sets show a correlation over 85%.

Now, this is really interesting in that it melds with our work on Monetary Realism and monetary theory quite nicely.  Using Werner’s concept of disaggregation of credit we can clearly formulate how credit is being used at various times to benefit from improvement in the stock market.  If you’re not familiar with the concept of disaggregation of credit please see here.  But, in short, it is based on the understanding that our monetary system is almost entirely built around credit and how banks issue credit to perform various functions.  These functions can be both good and bad.

The concept of disaggregation of credit shows how there can be productive and unproductive uses for this credit.  Some forms of credit are purely good.  For instance, a business that takes out a loan to pay employees, expand operation, perform R&D is a form of productive credit.   An unproductive from of credit might be a trader who borrows on margin to leverage a position in a secondary market purely for market gains.

It’s interesting to note the tight correlation between margin debt and stock prices in our world that is so overly obsessed with nominal wealth.  And we even encourage the use of leverage in the chase for this nominal wealth.  Is that stabilizing?  Or is it more destabilizing than anything else?  I would argue that this obsession puts the cart before the horse, but that’s just me….

Chart via Orcam Investment Research:

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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • http://breedinginstability.com Mountaineer

    I’ve always liked this chart, but I do wonder how much of it is useless correlation. It seems entirely reasonable that nominal margin debt would track market capitalization. This feels a lot like the famous “cash levels as a percentage of portfolios at market peaks and troughs” chart that always gets tossed around.

  • Nils

    NYSE margin debt is measured in what?

    I like nominal wealth. The only kind of wealth I can spend ;)

  • http://www.orcamgroup.com Cullen Roche

    You spend your realized wealth. Nominal wealth is things like stocks or even worse, my company on a private market. It’s worth millions in my head, but possibly worth zero to everyone else, which means I shouldn’t build my spending plans around it. :-)

  • fin

    Great chart and nice explanation.

  • Henry

    Cullen, James Montier at GMO just released a paper on his take on hyperinflation. It reads very much like the one yor published a couple of years ago. I know Mr. Montier is one of the most respected economic minds in the industry. Great minds thinking alike? Anyway, keep up the great work Cullen. I’m sure most of your readers don’t often comment, but we read your thoughts daily and use them to better understand the complicated economic world we live in. Thanks again for the knowledge you provide.

  • http://www.orcamgroup.com Cullen Roche

    Yes, it’s a near verbatim of my paper from 2 years ago….

    http://pragcap.com/james-montier-joins-the-hyperinflation-debunking-train

    And thanks for the compliments!

  • http://www.stableinvesting.com Ryan Melvey

    Professor Steve keen has some pretty cool charts linking margin debt to stock prices, mortgage debt to house prices, and corporate debt to changes in investment.

  • Nils

    What’s the left Y axis?

  • George H

    The market can’t go down.

  • http://breedinginstability.com Mountaineer
  • Manolete

    Useless.

  • LVG

    More useless than your comment? Not a chance.

  • Blissex

    Barry Ritholtz has also published a much longer term, and thus far more amusing, graph of margin stock purchasing:

    http://bigpicture.typepad.com/photos/uncategorized/2007/10/20/margi_20071019205652.gif

    and like most financial graphs it shows a massive surge starting in 1995 (and a smaller one in thre 1980s).

    «It’s interesting to note the tight correlation between margin debt and stock prices in our world that is so overly obsessed with nominal wealth. And we even encourage the use of leverage in the chase for this nominal wealth. Is that stabilizing? Or is it more destabilizing than anything else? I would argue that this obsession puts the cart before the horse, but that’s just me….»

    It is also J. K. Galbraith, who in “The Great Crash 1929″ wrote:

    «The purpose is to accomodate speculators and facilitate speculation. But the purposes cannot be admitted. If Wall Street confessed this purpose, many thousands of moral men and women would have no choice but to condemn it for nurturing an evil thing and calling for reform.

    Margin trading must be defended not on the grounds that it efficiently and ingeniously assists the speculator, but that it encourages the extra trading which changes a thin and anemic market into a thick and healthy one.»

    Sometimes I get the impression that the enormous easing of margin lending over the past few decades is all part of a vast pump-and-dump operation run by the financial industry and the Fed to sucker pension funds and individuals with 401k accounts. Time will tell… :-)

  • Nils

    Nice theory, but I’ve never seen a 401k or Pension fund using margin.

  • Johnny Evers

    Cullen, I’m curious if you use margin debt to invest in secondary markets?

  • Blissex

    «Nice theory, but I’ve never seen a 401k or Pension fund using margin.»

    I am sorry that you did not understand that the point of using margin by the financial industry supported generously by extraordinarily loose Fed policy is to pump valuations ever higher, so that pension funds and 401k owners are suckered in with the mirage of massive tax free capital gains forever. Until the dump phase happens…

    Also, pensions funds do seem to use margin, or other forms of leverage. For example in this page:

    http://macroblog.typepad.com/macroblog/2011/10/state-and-local-fiscal-fortunes-follow-the-money-collected.html

    there is a graph of aggregate locla public sector pension fund related investments, and it looks like they follow the SP500, with much higher variability (but curiously mostly downwards — such are the skills of Wall Street).

  • But What Do I Know?

    Pensions in the last decade have been increasing their investment in “alternatives,” most of which use leverage in one form or another . . .