When the herd is begging, stealing and especially borrowing to get in on the market action, take note.
Some might even say be afraid.
I don’t know if that’s the best reaction at this point. But today I read a startling statistic. And it suggests that we should all be paying close attention to what our fellow investors are doing right now.
According to the Wall Street Journal, margin debt climbed to a record high in February.
As a refresher, margin debt is basically a short-term loan. It enables investors to buy more stock than they actually have money for in their brokerage accounts.
To get this margin loan, investors must pledge securities they own (stocks or bonds) as essentially collateral to get the loan from their brokers.
So, this rising margin debt means investors are borrowing more money from their brokers so they can buy more stocks.
This is a clear sign that individual investors were feeling uber-bullish about stocks in February.
But why should we worry when investors are, en masse, so bullish?
Well, because when the level of borrowing hits a fever pitch, it’s often the last breath of a tired bull.
So, how much did investors borrow from their brokers in February?
Here’s the money quote from the WSJ piece:
The amount investors borrowed against their brokerage accounts climbed to $528.2 billion in February, according to the most recent data available from the New York Stock Exchange, released Wednesday. That is up 2.9% from $513.3 billion in January, which had been the first margin debt record in nearly two years.
Indeed, there’s been a steady rise in margin debt over the past few months. All that borrowing and buying has helped contribute to the post-election bubble of sorts we’ve seen that’s taken stocks to all-time highs.
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This kind of action can serve as a contrarian indicator. Here’s why …
Rising margin debt usually indicates a situation where investors have put aside risk … and perhaps forgotten that stocks don’t just go up, but they also go down.
We know this because margin debt has a history of surging to record highs right before market bubbles burst.
It happened in 2000, and it happened in 2007.
Will it happen again in 2017?
The jury is still out on that. But consider that the S&P 500 is on pace to finish in the red in March. As of this writing, the broader measure of the domestic equity market is down 0.08% over the past four weeks.
That’s not what I would call a busted bubble. However, it is what I call a market stall.
Now, one point that the WSJ article made that is important to remember is this …
Margin debt rose to record highs several times during the past eight years of this bull market.
Moreover, the article points out that when measured against the rising value of the market, the current level of margin debt is not a record.
Margin debt totaled 2.5% of market capitalization on the New York Stock Exchange in February, roughly level with where it was in 2013.
Still, when I see contrarian signs of unbridled bullishness, I start to think about ways you can protect your money.
That could mean taking profits in winning positions … or tightening stop-loss orders … or taking positions on the short side and looking for opportunities in non-correlated, alternative investments.
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Why do this?
Well, because unlike some margin borrowers, Uncommon Wisdom Daily editors know that stocks can, and often do, go down.
So if you’ve gone into margin debt in your account to double down on the bull market, well, consider yourself warned.
I want to know what you think, so if you have a comment or question about today’s Afternoon Edition topic, or any of the topics we cover, let me know. All you have to do is leave me a comment on our website or send me an e-mail.
The buying, whether on margin or not, continued during Thursday’s session. The broader indices all ended the day higher. The Nasdaq closed at a record high (up 0.3% to 5,914.34), even with Lululemon Athletica’s (LULU) 23.4% post-earnings slide.
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Good luck and happy investing,
Uncommon Wisdom Daily