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“The Constitution is not an instrument for the government to restrain the people, it is an instrument for the people to restrain the government - lest it come to dominate our lives and interests.”
― Patrick Henry
Whenever Margin Debt Goes Over 2.25% of GDP The Stock Market Always Crashes
What do 1929, 2000 and 2007 all have in common? Those were all years in which we saw a dramatic spike in margin debt.
NEW YORK, NY – Designer Vera Wang and Coty CEO Michele Scannavini stand amoungst a sea of traders at the New York Stock Exchange Coty goes public on the New York Stock Exchange on June 13, 2013 in New York City. Global beauty company Coty made its public debut today. (Photo by Jemal Countess/Getty Images)
In all three instances, investors became highly leveraged in order to “take advantage” of a soaring stock market. But of course we all know what happened each time. The spike in margin debt was rapidly followed by a horrifying stock market crash. Well guess what? It is happening again. In April (the last month we have a number for), margin debt rose to an all-time high of more than 384 billion dollars. The previous high was 381 billion dollars which occurred back in July 2007. Margin debt is about 29 percent higher than it was a year ago, and the S&P 500 has risen by more than 20 percent since last fall. The stock market just continues to rise even though the underlying economic fundamentals continue to get worse. So should we be alarmed? Is the stock market bubble going to burst at some point? Well, if history is any indication we are in big trouble. In the past, whenever margin debt has gone over 2.25% of GDP the stock market has crashed. That certainly does not mean that the market is going to crash this week, but it is a major red flag.