Thursday, April 30, 2015
It's another new record for the stock market.
The S&P 500 rallied to a new all-time high last Friday – its highest closing price ever. And investors are celebrating the event.
But the record I'm writing about today is somewhat less celebratory... And if history is any indication, it means it's time for traders to become cautious.
Let me explain...
Last month, New York Stock Exchange (NYSE) margin debt surged to an all-time high of $476 billion.
Margin debt is money that investors have borrowed to put into the stock market. So, to put it another way... last month, investors borrowed record amounts of money to put into the stock market at record-high prices.
That's not good news.
You see, there's a strong correlation between record-high margin debt and tops in the stock market – especially following several years of higher stock prices.
For example, in March 2000, NYSE margin debt reached a record high of $278 billion. That was the same month the S&P 500 peaked at 1,525. One year later, the S&P 500 was trading at 1,100 – down 28% from its all-time high.
NYSE margin debt peaked again in July 2007 when it reached $381 billion. That month also marked the peak of the stock market, with the S&P 500 hitting a high of 1,550. Sixteen months later, the index was cut in half.
The ability to borrow money helps push stock prices higher as investors buy stocks at ever-increasing prices. It's tempting to borrow money and put it in the stock market. After all, if you can borrow money at 2% and then invest it and make 10% or more, then you look like a genius.
But leverage is a double-edged sword. As I explained in January, the stock market isn't known for making the majority of investors look smart. So when everybody is borrowing money with the hopes of levering up their returns, it's usually a good time to get cautious.
When stock prices start to fall and investors start to lose money on their leveraged bets, selling pressure increases as investors dump their shares in order to pay off the margin debt.
So, the stock market making a new high is good news. But the stock market making a new high on borrowed money suggests this bull market may be nearing its end.
Best regards and good trading,
As Jeff mentioned, NYSE margin debt is at an all-time high. And this kind of leverage destroys investors. "Leverage is financial crack," he writes. "The first hit feels good. It's a trader's high... We want more of it. So we use it again, and again, and again – until we're addicted." Eventually, though, "it kills us." Learn more here.
Jeff recently showed readers three other caution signs that shouldn't be ignored right now. In short, the market is long overdue for a correction and he recommends raising cash today. Get all the details here.
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