Top Advisors Corner

Alan M. Newman: Rationales & Targets

Alan Newman

Alan Newman


When total margin debt topped at $416 billion in July 2007, the S&P 500 was at 1455.  Despite a decline of 13.8% in margin debt over the next two months, the SPX climbed 4.9% and then hit a new record high in October.  Margin had climbed back a bit but did not approach the July high, but nevertheless, that was the top for prices, which collapsed by 50% in little more than 16 months. The pattern today is quite similar.  Total margin debt topped in February at $502 billion and while margin has declined a bit over 5% in the last two months, prices are nominally higher.  If the long slide is destined to begin 58 trading sessions after the peak in margin debt as it did in 2007, then the slide will begin this week. 



Margin has been the primary demand tool since the March 2009 low.  Domestic mutual funds have seen $358 billion in outflows while total margin debt increased by over $300 billion.  The bull cannot survive without increasing leverage.  We cannot think of a better example of a stock market fantastically overloaded with risk.  Support remains far below, at approximately the round number of Dow 16,000.  Average volume has fallen close to 12% over the last month as buyers are not ready to step up to higher prices and the proof is the continuing contraction of new highs.  The VIX close of 11.36 is the lowest since 2007, not the best of times to own stocks.  Short term, the Dow remains positive until a close below 16,312, down 1.8% from Friday’s close. 

April Non-Jobs Report

We are struck by how poor the economic statistics actually are and by how the media continues to focus on the headlines the Fed and the BLS would have them focus on; how the public is misled as if massaging the numbers will increase confidence in order to rebuild the economy. 

It isn’t working.  In the last year, the population rose by 2.26 million but those not in the labor force rose by 2.2 million, or 97.5% of the total.  The labor force participation rate dropped to a 36 year low and almost all job gains were account for by temporary or part time work.  We have often referred to the work of John Williams (see the Shadowstats website—http://bit.ly/1ncsPHL).  In a recent report after the BLS release of April data, Mr. William’s maintained that the  April unemployment numbers showed a “deepening economic disaster,” misleading stats including job gains bloated by “concealed and constantly shifting seasonal adjustments,” impending downside corrections to GDP growth and stagnant construction spending. 

The government’s stats are woefully misleading.  For instance, the February headlines reported a two-tenths of a percent decline in the unemployment rate and 170,000 jobs created, but the greater truth was full time employment fell by 212,000, while 382,000 Americans took part-time jobs.  There’s your 170,000 gain in total employment.  See http://bit.ly/1cyq0cm for more information concerning “missing workers.”  Nothing is as it appears. 

A Few Paragraphs On Risk
(EXCERPTED FROM THE CURRENT ISSUE OF CROSSCURRENTS)

The Office of the Comptroller of the Currency (OCC) released the fourth quarter 2013 report on derivatives, showing total notional values of $237 trillion, down a nominal $3 trillion from the third quarter report.  Despite a modest pickup in the government’s stated data for GDP, the 5-year trend for growth remains far outpaced by the fantastic growth of derivatives in bank portfolios.  It is our view that this gigantic tally represents a fair appraisal of systemic risk and the more risk is maintained, the more impedance is generated to hinder future economic growth.  The simplest inference is that America’s best growth years are behind it, a posit that seems increasingly likely when examining the last dozen years. 

While derivatives do not necessarily equate directly to leverage, these financial constructs have enabled leverage on a far greater scale than ever seen in our history.  We can see vast increases in leverage in every aspect of our society.  Federal government debt has more than tripled since 2000 and is rising at an annual rate of over 8.4%.  At the current pace, there is not only no hope of ever paying down debt to a manageable size, we are likely ensuring a massive problem in the next 10-20 years when the only solution to accommodate economic growth will be an inflationary phase that makes the 1970s look tame by comparison. 

Our charts and comments regarding margin debt in the stock market are more proof of how much leverage is built into our society.  When former Fed Chairman commented 18 years ago why the Fed had refused to raise margin rates under Reg. T, he posited that alternative methods to raise borrowed money made an increase in margin rates a meaningless move.  No doubt the ease of acquiring home equity lines of credit and even loans via credit card advances helped fuel the tremendous mania in 2000.  Meanwhile, what the former Fed Chairman did not say was that the Fed’s reluctance to move favored the financial industry, which would have lost one of their big profit centers had margin rates been raised.  As usual, the rationale has always been to protect the financial industry.  The public interest is avoided.

There is a wide gap in between the derivative portfolios of the top four commercial bank portfolios and the next five but altogether, they account for 99.2% of all derivatives.  We almost suffered a worst case scenario in 1987, another worst case scenario in 1998 and yet another in 2008, yet we remain on track for another worst case scenario as if this is the accepted standard.  As we have said on many occasions, it is not a matter of if, but when.  A failure of any of these banks in a worst case scenario will likely threaten the entire financial system.  

Alan M. Newman, Editor, Crosscurrents
516-557-7171
www.cross-currents.net