Margin, Mania and Madness

10/03/2017 5:00 am EST


Alan Newman

Founder, Crosscurrents Publications, LLC

Our net liquidity measure for the U.S. stock market moved up nominally in May and June and perhaps there was some hope that the worst had been seen and participants might come to their senses. No such luck, asserts Alan Newman, market timer and editor of CrossCurrents.

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Total margin debt (NYSE plus NASDAQ) once again set a new record of over $594 billion in July and liquidity dropped. We can only suppose there have been worse bubbles.

The Roaring Twenties were certainly absurd as was the Nifty Fifty in 1972, the great tech mania of 1999-2000, and the coupled housing and stock bubble of 2007. All too often, it has happened before, so we cannot ever dismiss the notion that participants have quite literally literally, lost their minds.


When it comes to madness, there can be no degrees of correctitude. With apologies to William Shakespeare, lunacy by any other name is still lunacy.

Leverage, in the form of total margin debt, has grown to nearly double what the tech mania engendered, a circumstance we all would probably have considered preposterous after that humongous fall from grace.

One would have been excused for thinking they’d never see a mania of that magnitude again in their lifetimes, just to experience the same circumstance only seven years later and then again, today.

The only reasonable conclusion is an epic unwind is in the offing, with similar parameters to the previous two bear markets from 2000-2002 and 2008-2009.

With leverage at such as extreme, it should not take very much to catalyze a substantial correction. Margin debt versus GDP has achieved another new high this year, well in excess of any previous year except the possibility of 1929, for which we do not have data.

While sentiment is excessively optimistic, it is also showing a rather stunning lack of pessimism and fear and zero recognition of the inevitable reality that bear markets follow the bull.

For the calendar year thus far, the Investor’s Intelligence tally of advisors averages only 17.9% bears. From 2003-2016, advisory bears averaged 25.3%.

The last time the mutual fund cash ratio was as much as 4% was August 2012. From 1984 through 1999, the cash ratio averaged 8.3% but has averaged only 3.2% this year. Reality, as referenced above, is only a step away.

The lack of intraday movement for the Dow has been stunning for quite awhile and it is beginning to look like the spring is coiling for something really big.

Going back over 25 years, the ten-day of the difference between the Dow’s daily high and low has averaged 1.38%. It is currently less than one-third the average at 0.43% and has not seen the 1% level since mid-November 2016. Last week, daily range was only 0.35% and we can’t envision it getting any narrower unless the Dow simply stops trading.

We have added the label of “major support” to Dow 17,883, which is also our “target” low for 2017. While the odds for that circumstance are falling every day due to the restrictions of time itself, we hasten to point out that the Dow swooned over 16% in just over three months in 2015, and after a countertrend rally during the correction, collapsed 15% in just over one month.

Just a friendly reminder: the dollar was a likely culprit for the Crash in 1987. The dollar hasn’t been this low since December 2014 and we see no obvious support level. Put it all together with the coiling of the spring and we have the right stuff for a correction. It’s actually pretty scary.

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