On My Radar: Margin Debt, Valuations And Vacation by Stephen B. Blumenthal, Capital Management Group
unt of margin debt in billions. Note in the bottom section the amount of margin debt is nearly twice as much as it was in early 2000 and much higher than it was at the prior peak in late 2007. The red line plots the amount of margin debt over time.
What I like about this chart is that it also plots a six-month smoothing line (dotted green line) and shows the performance of the Dow Jones Industrial Average from 1965 to present when the total margin debt is above its six-month smoothing (red line above green line).
The next chart looks at Margin Debt as a percentage of GDP. Here it is just slightly higher than the peaks in 2000 and 2007. Also plotted is a 15-month smoothing that shows it is better to be in the market when margin debt is above its trend line. This is the case about 58.9% of the time, since 1948.
The next chart looks at margin debt as a percentage of market value. Note how low margin debt was in the late 1940s and again after the 1974/75 market crash. Also take a look at the 2000 high and where we are today relative to 2007.
Finally, as it relates to margin debt, I came across this next chart when researching through the NDR site. The bottom section sets two bands: above the upper band (green dotted line) reflects periods of excessive speculation, below the lower band reflects periods of excessive pessimism and between the bands is neutral. The returns for the market is reflected in the upper left had section of the chart. The yellow highlight shows us where we are today and the DJIA’s historical returns when “between bands” (based in this measure).
In sum, the high level of margin debt is concerning but not yet a problem. Let’s keep a watch for a change in trend.
Valuations
The market has been treading water and perhaps a good part of that struggle is the current level of high valuation. So let’s take a look at a few different valuation measures and start with my favorite (Median PE). Valuation can tell us a great deal about what 10-year forward returns might be. Buy low, sell high as they say.
The yellow circle highlights the July 31, 2015 PE of 21.8 putting the market (by this form of PE measurement) at an “Overvalued” level. The green arrow shows the market to be fairly valued at 1569.61 based on a 51.4 year mean. A reasonably good guess in my view.
As we’ve shown before, the forward returns are not so good when the market is in an overvalued state. At a median PE of 21.8, the current reading is in the 5th quintile or highest 20% of recorded month-end market median PE valuations. Here is a plot of returns, 1984 through 2014, based on whether PE was low (Quintile 1) or high (Quintile 5) and what happened over the subsequent 10 years.
Clearly it is better to buy when valuations are low (Quintiles 1, 2 and 3). We want to be very careful (and hedge) when in Quintile 5. Note the light purple line in the chart above. We are in Quintile 5 today. This measure is projecting a 10-year forward return of just 2.94%.
Next is a summary of several popular valuations measures.
On their own, high valuations can grow to become move overvalued. Valuations are a very poor timing tool. However, they are a very good risk level tool and can help us identify periods in time where we should become more conservative. That is why I favor risk management (hedging processes) and other diversifiers when risk is high (like today).
The next chart (red arrow) shows us that the worst market declines have come during recessions and warn us to be most concerned when our beginning point is high. The yellow highlight reflects today’s current overvalued state based on the above data courtesy of Doug Short.
Put your glasses on for this next chart or simply note that the majority of various other valuation indicators are red (extremely overvalued or moderately overvalued). “Warning Will, Warning Will” – I picture that robot from one of my favorite childhood shows, Lost in Space.
The good news is that, while we remain patient for better value, we investors have tools available that allow us to participate and protect (hedge) and broader strategies that enable us to build stronger and more broadly diversified portfolios. Such strategies are called tactical and alternative strategies.
“This is the one thing I can never understand. To refer to a personal taste of mine, I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the “Hallelujah Chorus” in the Buffett household.
When hamburgers go up, we weep. For most people, it’s the same way with everything in life they will be buying–except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.” Warren Buffett
Like Buffett, we’ll sing the “hallelujah chorus” when the hamburgers go down in price. Right now we should probably weep.
Keep one eye on the trend indicators (Trade Signals) and keep the other on the lookout for a turn down in margin debt.
Trade Signals – Volume Demand is Greater than Volume Supply (New Buy Signal) – 08-5-2015
More buyers than sellers drives price higher. One of the charts I post each week measures volume demand vs. volume supply. The buy and sell signals are posted below. A new buy signal was triggered on July 30, 2015. This, along with favorable trend and sentiment measures, causes me to lean bullish.
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: The Primary Trend Remains Bullish for Stocks
- Volume Demand is Greater than Volume Supply: Buy Signal for Stocks
- Weekly Investor Sentiment Indicator:
- NDR Crowd Sentiment Poll: Extreme Pessimism (short-term Bullish for stocks)
- Daily Trading Sentiment Composite: Extreme Pessimism (short-term Bullish for stocks)
- Don’t Fight the Tape or the Fed: Modestly Bearish – Watch Out for Minus Two
- U.S. Recession Watch – My Favorite U.S. Recession Forecasting Chart: Currently signaling No U.S. Recession
- The Zweig Bond Model: The Cyclical Trend for Bonds is Bullish
Click here for the link to all of the charts.
Vacation Time
“Twenty years from now you will be more disappointed by the things that you didn’t do than by the ones you did do, so throw off the bowlines, sail away from safe harbor, catch the trade winds in your sails. Explore, Dream, Discover.”
–Mark Twain
The word lucky comes to mind. So does the word grateful. We took the whole gang to Lake George last weekend. The above photo is from Jim and Maureen’s back deck (Susan’s brother and sister-in-law). What a place. Camp Jim we call it. Oh, and the fine red wine.
I spent a good bit of time picking Jim’s business brain. He built an amazing sales and distribution business. I always gain valuable and needed insights.
The little guy, Kieran, in the next shot is watching the dog fetch a tennis ball from the lake. That game can go on all night so you can see the balance of disinterest in that most recent toss. I do love how much they love each other.
A few more days off for me next week. We rented a beach house in Avalon, New Jersey. Springer’s Ice Cream is in my immediate future. It will be fun. Explore, Dream and Discover! I sure hope to and wish you the same.
With kind regards,
Steve
Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Chairman, CEO and CIO. Steve authors a free weekly e-letter titled, On My Radar. The letter is designed to bring clarity on the economy, interest rates, valuations and market trend and what that all means in regards to investment opportunities and portfolio positioning. Click here to receive his free weekly e-letter.
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