A client said: “U.S. margin debt outstanding remains at a very high level; as such, I expect U.S. stocks to correct further.”
We last discussed the overbought condition in U.S. stocks as measured by U.S. margin debt outstanding in our January 29, 2014 blog entry (“Record Rise in Margin Debt Outstanding = Single-Digit Stock Returns in 2014“). U.S. margin debt outstanding stood at $478.5 billion at the time (measured as of December 31, 2013), after rising by $123 billion over the previous 12 months. The rapid rate of margin debt growth at the time suggests a highly overbought market. For comparison, the 12-month increase in margin debt outstanding leading to the March 2000 peak was $134 billion; for July 2007, an unprecedented $160 billion. At the time, we stated that this rapid accumulation of margin debt would lead to tepid stock returns going forward. The S&P 500 stood at 1,848.56 as of December 31, 2013; as I am typing this, the S&P 500 is trading at just shy of 1,900. After two years, the S&P 500 has gone nowhere; although your portfolio would’ve performed well if you had an overweight in consumer discretionary and tech; less so if you had an overweight in energy or materials.
As of December 31, 2015, U.S. margin debt outstanding stood at $503.4 billion–a tepid $25 billion increase over a period of two years. With the recent sell-off in U.S. stocks, margin debt would likely have declined by at least $20 billion this month. This means U.S. margin debt outstanding as it stands today is likely to have revert to its December 31, 2013 levels. Figure 1 below shows the 3-, 6-, and 12-month absolute change (in $ billions) in U.S. margin debt outstanding from January 1998 to December 2015.
A margin debt outstanding of around $480 billion is still high by historical standards; however–based on the 3-, 6-, and 12-month rate of change–U.S. margin debt outstanding is actually at an oversold level–reminiscent of similarly oversold levels in late 1998, early 2008, and the 2nd half of 2011. In two of these instances (late 1998 and the 2nd half of 2011), the S&P 500’s subsequent returns were phenomenal (38% and 27%, respectively, over the next 12 months); in the case of early 2008, however, not so much. With that said, March 2008 still represented a tradeable bottom–as long as one got out of U.S. stocks by summer of 2008.
As I discussed with my clients, I do not believe the current liquidation in energy, materials, and EM assets will morph into a globally systemic event. As such, I believe U.S. stock returns will be decent over the next 6-12 months.