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Unwinding of Record Margin Debt Could Lead to Crash
07/10/2018 6:00 am EST
Total margin debt rose $16.6 billion to another all-time record high of $668.4 billion in May. But everything is up, so the proper question is “how we compare to the past?” There are quite a few answers and they’re all scary, cautions Alan Newman, market timer and editor of CrossCurrents.
Compared to GDP, margin debt is at a record high. For the first time since 1929, margin debt soared to over 3% last year, ending the year at 3.22%, and now stands at 3.27% of GDP. Margin debt has been over 2% of total stock market capitalization for nine years. This year’s 2.17% is the highest since the 1929 mania.
Vis-a-vis valuations, the phrase off the charts barely touches how massively stocks are overvalued. We typically refer to the Shiller’s CAPE (Cyclically Adjusted Price Earnings) ratio for illustrative purposes.
CAPE is at its second highest reading in history, exceeded only by the phenomenal tech mania that swept all of Nasdaq to a 250 P/E by March 2000.
Although NASDAQ's overall P/E is far lower today, the rest of Nasdaq pales in comparison to what drives the index: the so-called FAANG stocks — Facebook (FB), Apple (AAPL), Amazon (AMZN), Netflix (NFLX) and Google (GOOGL), also known as Alphabet.
These five issues now represent 10.6% of all stock market wealth, a simply incredible statistic. As far as we know, total stock market wealth has never been this concentrated.
While Apple might appear reasonably valued at a mere 18 P/E, the other four FAANGs come in at an average 133 P/E and are valued at a humongous $2.3 trillion, or one in every $14 of wealth in U.S. stocks. We are immersed in quite probably the riskiest environment of all time.
Stocks fall far faster than they rise and despite the calm, despite the lack of bearishness, despite the pronouncements that the bull market will not end anytime soon, we can only stress that an unwinding of margin debt could result in a crash.
We cannot overstate the dangers of the long side. We remain bearish and still maintain a bear market target of Dow (DJI) 14,719, down more than 40% from today.
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