Monday, December 9, 2013

Hussman's Ratio of Margin Debt to Commercial and Industrial Loans

In Hussman's Sunday column, linked earlier, he mentioned that,

"Among the litany of other classic features of a speculative bull market peak, margin debt on the NYSE has surged to the highest level in history, and at nearly 2.5% of GDP, exceeds all but two months in 2000 and 2007. The amount being borrowed to buy stocks on margin is now 26% the size of all commercial and industrial loans in the entire U.S. banking sector."
That last part is astounding, and I had to check to make sure that it is true (with the NYSE and the Fed). Since I had already pulled the data, I figured why not see how this ratio - which is a novel contribution by Hussman - has varied over time.

The ratio spent much of the second half of the 20th century below five percent. It wasn't until the Fed induced bubble in the mid 90s that it went parabolic, cracking 15% for the first time ever in September 1997.

Here are all the months when the ratio has been above 25 percent: February and March 2000; April through August 2007; February through May 2011; September and October 2013.

Keep in mind that we are essentially deflating the series using commercial and industrial loans, which grow swiftly themselves during credit bubbles.

Every cockpit indicator is screaming that the plane is about to crash into terrain, but the response of almost all other investors is to push the throttles forward.


eah said...

"this time it's different"
"new market paradigm"
"most hated rally in history"

seems a run-up or sideways squirm into the new year is more likely than a significant decline

but what do i know?

James said...

Thanks for sharing the chart. It's pretty striking evidence of a stock bubble-- especially when, as you said, commercial debt is also in bubble territory.

Anonymous said...

I wonder: is much of the leverage short rather than long on equities?

In my view large hedge funds are leveraging their short positions in US junk bonds and high priced, low-profit stocks and going long on US bank notes and hard asset classes in inflationary emerging markets.

There will be a correction in the US debt + equities markets once the fed begins pulling back and I don't think most investors realize how long and painful that will be.

CP said...

I think this is all margin borrowing to buy - cash advances to the muppets to buy stocks. But the NYSE doesn't make it entirely clear.

PD said...

so you guys aren't borrowing at sub 4% to buy wells fargo at 2.7% divi and 11x earnings?

I mean they earn $9 for every $100 of price. They payout $3 in dividends, keep $6 and reinvest @ 13%, creating $0.78 on incremental wealth. So next year they have $9.78 or earnings on $100 of pricing. This means they are growing earnings at 8.7% and you as an equity owner can make a positive spread of 4.6%

I get that leverage creates problems, but interest rates are so low it creates a payoff curve that is relatively priced correctly.

back in 2008 the economics were much different. Interest costs were 6% and the earnings yields [13-14x) were 7%. Price to book value was >3.5x.

Today the spread is 400bps, and TBV is 1.8. In reality this pe is 10% cheaper, earnings yield over interest costs are 400bp, and price to book value is 50% cheaper. This sounds significantly more compelling given the relative valuation of 2007-2008!

So as companies are able to structurally lower their borrowing cost by borrowing at 3-4% and then have overcapitalized balance sheets, they can increase invest in their businesses going forward.

So the trick is more what are they going to buy vs. Hussman's simplified marco economic analysis.

I am not sure there is anything cheap, nor can i justify the rally in my own mind, but it is important to keep things in perspective. There is a pretty simple case to be made that equities are actually quite cheap, some might even are only on hole 9 of 18 in terms of the business cycle [remember we had massive deflation].

We haven't seen a lot of M&A, leveraged buy outs, so the credit cycle is not in the late stages that is for sure.

Also there will be a correction but what causes it and the "factors" that will lead that recession are probably more suited for bottom up fundamentals [ie companies do dumb things with money] versus some chart from an economist...

my two cents...

CP said...

PD I couldn't figure out what you are talking about. Are you actually buying Wells Fargo stock on margin?

PD said...

So to clarify, I make the point that equities are not that expensive when interest rates are so low.

Secondly, given a equity investor cost of debt i can see why someone would use a leveraged approach.

Margin is not prudent, but I can see why ppl would use it, because they can make money on it - especially if you borrow money on a mortgage at 3% and invest in a 8% earnings yield, which pays a 2.9% divi.

CP said...

Buying a non-controlling equity position in a company with leverage to capture an earnings yield spread is not sound.

PD said...

it is a moral dilema against leverage that makes it not sound, or the non controlling aspect that makes it not sound (or both).

With leverage many investors, including buffett have used insurance floats to capture earnings yield. Buffett is one of the few players that can make equity investments and PE investments backed by his insurance portoflio in the manner he does. and he has outperformed the market over time, some might say just by having a lower beta than his insurance portfolio.

With control, I am not convinced if I had control of wells fargo that I would do a better job, nor would it make the return on a leveraged investment any better. Maybe we have to make the assumption that one would want to purchase wells fargo and one would have the appetite for risk.

I also think if you had a million dollar portfolio and you put 50k in wells fargo on margin in the manner i describe, that it might have merit. If you have a million dollar portfolio and you tried to make a $4mm investment in wells fargo, that is a much different proposition.

CP said...