Misdiagnosing The Risk Of Margin Debt, by Lance Roberts

Margin debt helps keep stock markets afloat. From Lance Roberts at realinvestmentadvice.com:

This past week, Mark Hulbert wrote an article discussing the recent drop in margin debt. To wit:

“Plunging margin debt may not doom the bull market after all, reports to the contrary notwithstanding.

Margin debt is the total amount investors borrow to purchase stocks, which historically has risen during bull markets and fallen during bear markets. This total fell more than 6% in October, according to a report last week from FINRA. We won’t know the November total until later in December, though I wouldn’t be surprised if it falls even further.

A number of the bearish advisers I monitor are basing their pessimism at least in part on this plunge in margin. It’s easy to see why: October’s sharp drop brought margin debt below its 12-month moving average. (See accompanying chart.)”

“According to research conducted in the 1970s by Norman Fosback, then the president of the Institute for Econometric Research, there is an 85% probability that a bull market is in progress when margin debt is above its 12-month moving average, in contrast to just a 41% probability when it’s below.

Why, then, do I suggest not becoming overly pessimistic? For several reasons:

1) The margin debt indicator issues many false signals
2) There is insufficient data
3) Margin debt is a strong coincident indicator.”

I disagree with Mark on several points.

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