The accumulated amount of margin debt utilized by investors to buy risky assets has consistently predicted turning points in the stock market in the past. As illustrated by the below graph the amount of accumulated margin debt started to decrease before the 2000 and 2008 stock market peaks. During the current debt cycle (post 2008 financial crisis) the level of margin debt in billion of dollars peaked in early 2015. What is different this time around is that the S&P 500 stock index did not implode shortly after the top of the margin debt cycle.
Accumulated margin debt in billion USD vs. the S&P 500:
Is it different this time around? Will the S&P 500 index keep on climbing to new heights while investors deleverage? I personally do not think so. I believe the current discrepancy between the movement of margin debt and S&P 500 is proof of irrational exuberance, where retail investors desperate to miss out on the fun and foreign investors desperate for yield pump up stock prices one last time.
The below chart (blue line) illustrates that the "dumb" money is a lot more confident in the current market situation than the "smart" money. The "smart" money is defined as investors who have been good at timing the market in the past.
Smart money vs. dumb money confidence spread:
Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving any compensation for it.
