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Are stocks in a bubble? While leverage has returned to the stock market driving up
stock prices and aggregate demand in the process, margin debt is still shy of its all-time high as a percentage of GDP, so there is certainly some headroom for further rises. A look at the following 5 charts illustrate that contention quite clearly.
So writes Steve Keen (www.paecon.net) in heavily edited and rephrased excerpts from his original article* as posted in Issue No. 64 of the Real-world Economics Review (subscribe for free here) under the title A Bubble So Big We Can’t Even See It.
[The following article is presented by Lorimer Wilson, editor of www.munKNEE.com and may have been edited ([ ]), abridged (…) and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.]
Keen’s article contains the following charts from www.debtdeflation.com/blogs and edited comments that I want to share with you:
Ratio of Margin Debt to GDP – correlation 0.945
The ratio of margin debt on the New York Stock Exchange as a percentage of GDP…has a correlation of 0.945 as illustrated in the chart below.
It should be noted that there are elements of spurious correlation here: they were both generally rising over 1955-2013, but one can also make a causal argument that increasing levels of debt levered up the gap between asset and consumer prices. This assertion of course directly contradicts a famous proposition in academic finance—the “Modigliani-Miller theorem” that the level of debt has no impact on the level of asset prices—which is another good reason to take it seriously.
Change in Margin Debt to Change in the Dow – correlation 0.59
Both the rate of change of margin debt (relative to GDP) and the rate of acceleration of margin debt correlate strongly with change in the Dow over the past six decades.
The correlation of the change in debt with change in the Dow is stronger than the correlation of acceleration – 0.59 versus 0.4 (see below)– but both are pretty strong for correlations over more than half a century, especially since conventional wisdom asserts they should both be zero.
Margin Debt Acceleration to Change in the Dow – correlation 0.4
The correlations have also risen as the level of debt has risen – both aggregate private debt and, in the USA’s case, margin debt which is specifically used to buy shares.
Change in Margin Debt to the Dow in Recent Years – correlation 0.69
Margin Debt Acceleration to Change in the Dow – correlation 0.6
Does rising/accelerating margin debt cause the stock market to rise, or does a rising stock market entice more people into margin debt?
Obviously there will be some cumulative causation here: both statements are going to be true to some degree, but this also implies a positive feedback loop, which is part of the explanation for why stock prices are so volatile….The market – and recently the economy – has risen…because of “the leverage effect”. Leverage has returned to the stock market, driving up stock prices and aggregate demand in the process.
How far can it go?
Margin debt is still shy of its all-time high as a percentage of GDP, so there is certainly some headroom for further rises… Fragility, rather than sustainability is the message I would take from the data provided above.
[Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.]
*http://www.paecon.net/PAEReview/issue64/Keen64.pdf (Copyright Steve Keen 2013)
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