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Margin Debt & Market Manias
03/17/2016 9:00 am EST
Bear market bottoms are marked by huge waves of fear; sentiment becomes overwhelmingly negative and prices decline beyond reason. Perhaps, even a panic, cautions Alan Newman, editor of CrossCurrents.
The negative divergences we have seen in breadth, volume and new highs are as significant as any divergences we have seen in our 51 years of market observations,
Margin debt equated to 2.9% of GDP. By comparison, margin debt was 2.5% of GDP two months before the 2000 tech mania collapse and 2.45% when the real estate and stock bubbles finally popped.
Thus, the 2015 top could very well be as significant as the previous two. To date, we have maintained the belief in two bear market targets.
The higher target is Dow 14,719, representing the print low on October 11, 2013. The lower target is based on a regression line representing 5% annualized gains over time. This line is at Dow 13,911.
However, these prior analyses presumed a far more emphatic recognition of the dangers ahead by all market participants. The problem is that reactions have been so muted that we now wonder if our targets are too bullish.
At the very least, a bear market bottom requires a phase known as capitulation, when the baby is thrown out with the bathwater.
Since the May 2015 high of Dow 18,351, we have no such circumstance. While there have been swings towards pessimism, they have been completely normal.
In the 187 sessions since the May 2015 high, excessive optimism has been visible 31% of the time, more than five times the days in which excessive pessimism took center stage.
It is clear that the vast majority of participants still believe the bull market is alive and well.
Total margin debt is a confirmation of a veritable stock market mania, the third such mania in only 15 years.
The April 2015 peak of $550 billion in margin debt was 32% higher than the 2007 peak and 83% higher than the 2000 peak. Both peaks were followed by margin liquidations of 50%.
If a similar outcome befalls the stock market now, there is another $228 billion of margin debt to be liquidated. At this point, we believe our call for a bear market bottom at Dow 14,719 is too generous.
Simply put, there is no way that level would be sufficient to catalyze the kind of capitulation that is the hallmark of major stock market bottoms.
Our projected liquidation of margin debt likely means a downside of at least 25%-30%, which would place the Dow somewhere between 12,846-13,763.
In our view, the present rally phase is nothing more than a bear market bounce. Bottom line: we are in a bear market and rallies are not to be trusted.
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