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Bulls leveraged up and rearing to go

Last week’s rally in the US market took just about everyone by surprise. No one could really put a finger on what was driving it. Climbing the wall of worry seems to be the cliched phrase thrown about at the moment, the theory being that stocks can still rally despite market jitters. Skeptics sit on their cash and as their fears are alleviated, they pile into stocks, pushing the market higher. As long as their worries are held in check the market continues to rally.

Overly simplistic but plausible enough. More interesting to me is where all this money is coming from. We know the markets have been awash with liquidity in recent years. The current M&A frenzy is testament to that. Michael Shedlock has postulated another reason that is fueling the current market rally on his blog Mish’s Global Economic Trend Analysis.

Margin Debt Drives The Market

The WSJ is reporting ‘Margin Debt’ Hits Record $353 Billion on NYSE

Investors are borrowing record sums of money to finance trades on the New York Stock Exchange, according to data due out from the Big Board today.

NYSE officials attribute the trend to recent regulatory changes effectively allowing both small and big investors to take on more leverage, or borrowed money, from their brokers. So-called margin debt, a broad measure of leverage, jumped 11% to $353 billion at NYSE in May, up from nearly $318 billion in April.

Wall Street has had a love affair with leverage in recent years, typified by hedge funds and private-equity firms that make use of it to buy companies and stocks and bonds.

Such financing can also amplify losses if investors’ bets go the wrong way. But regulators say that doesn’t necessarily translate into more risk. “I wouldn’t necessarily say that leverage equates to risk,” said Grace Vogel, executive vice president for member regulation at NYSE. “We feel that the amount of margin being collected by the firms is appropriate, given the strategies in [their customers'] portfolios.”

Under the financial industry’s old rules, investors who wanted both to buy shares in a company and use so-called options contracts on that stock to guard against an unexpected drop in the value of those shares would have to put up separate collateral for both the stock and the option. If the shares dropped in value, the customer might get a margin call, or request for additional collateral, from a broker to cover the price of the shares, even if the value of the option had increased.

Under a pilot program that the NYSE launched with eight brokerage firms in April, brokers can assess the portfolio as a whole. So if one part of the portfolio goes down but the other part goes up, the investor won’t necessarily get a margin call.

The upshot for investors is they don’t have to tie up as much money on one particularly investment, allowing them to borrow more to make other investments if they want to. …

Idea that the market is rising because of rising retail sales (or anything else) is fatally flawed. The market is rising because speculation has not stopped regardless of what economic activity is (or will) report. The market (in spite of what anyone thinks) is simply not any sort of leading indicator. Proof of that is easy to find. Please read Leading Economic Indicators for further discussion of this idea.

Leverage Kills

Leverage may kill but while things are hot no one cares. In the aftermath there are government investigations, Congressional inquiries, lawsuits galore, absurd regulations, and eventually government bailouts at taxpayer expense.

I am for Ron Paul because he alone will stop bailouts at taxpayer expense.

Top Call

On Tuesday July 10th and on the record in Quotes of the Day / Top Call I made a top call.

Sorry folks, I was wrong.

It is not the first time, nor will it be the last time I am wrong but I do not make top calls lightly. I was laughed at when I made a top call on housing in summer 2005. But who is laughing now about that call?

As for this call, I am sticking with it. The signs of speculation, of margin, of bullish sentiment, etc. in spite of deteriorating fundamentals are all around us. I see no reason to change that call.

By the way, it is not really margin debt that is driving the market. It is sentiment. Sentiment is driving margin debt. In spite of everything that has happened, speculators are still bullish on this market just as greater fools were bullish on housing in the summer of 2005. The longer this goes on, the greater the eventual collapse.

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