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S&P’s rise underpinned by borrowed money

US stocks are being propelled to fresh highs by investors borrowing a record amount of money in a high stakes gamble that is raising concerns over the potential for a sharp correction in the five-year bull run.

With the S&P 500 registering a fresh closing peak of 1,859.45 last week, margin debt – money borrowed to buy stocks – hit a record level in January, according to data from the New York Stock Exchange.

A trader signals an offer in the Standard & Poor's 500 stock index options pit at the Chicago Board Options Exchange (CBOE).
Getty Images
A trader signals an offer in the Standard & Poor's 500 stock index options pit at the Chicago Board Options Exchange (CBOE).

Peaks in the use of borrowed money have in the past been a precursor to big bear markets and viewed as a warning sign. Though margin debt has been hitting record highs in recent months, it now stands at $451bn on the NYSE, a rise of more than 20 per cent over the past year and above 2007's peak of $381bn. Five years ago it hit a low of $173bn.

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In past market peaks, excessive levels of margin debt exacerbated the subsequent slide in stocks, as investors were forced to quickly sell their holdings as prices fell, sparking a nasty downward spiral.

The rise in margin debt comes as questions are being asked about heady valuations, notably in biotechnology – where the Nasdaq Biotech Index is up 16.4 per cent since the start of the year – and in corners of the technology sector, which has seen Facebook spend $19bn on WhatsApp.

However, investors are not yet alarmed enough to sell out despite the S&P's 22 per cent rise over the past year.

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"We are beginning to see signs of froth; it's a yellow flag of caution and the market can move higher from here," said Kate Warne, investment strategist at Edward Jones. "It's not the time to move to the sidelines, you frequently get good returns in the final stages of a bull run."

Many investors also expect the US economy will rebound this spring after a harsh winter that has weighed on activity, prompting a sharp snapback in stock prices during February. After stocks slipped during January on soft data and emerging market turmoil, the subsequent rebound has vindicated investors who bought on the dip in prices.

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"If we see the economy bounce back and grow near 3 per cent, the S&P can rise further," said Steven Boyd, principal at Halyard Asset Management. He said the greater use of margin debt was a sign of confidence that the recent soft tone in data are attributable to cold weather and that pent up demand will drive a rebound in the coming months.

(Read more: Stock rally fades on concerns about Ukraine, but S&P stillsets record)

Mr Boyd said the record use of margin would be a concern if valuations for the S&P were around a forward earnings multiple of 20 times, rather than the current 17 times.

After the S&P's 30 per cent rise last year, most analysts and investors remain confident that the market can climb further this year as the Federal Reserve continues to reduce its monthly bond purchases and the economy and corporate profits grow.

Since the equity market bottomed in March 2009, the S&P, including the reinvestment of dividends, has risen more than 200 per cent.

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