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What record-high margin debt means for stocks

Trouble on market's margins?
Trouble on market's margins?

NYSE margin debt rose to an all-time high in March, according to recently released data from the stock exchange. But far from being a warning that stocks are getting frothy, some traders are using the news as a positive indicator.

At the end of March, NYSE margin debt sat at $476.4 billion, up from $464.9 billion at the end of February. And the wrinkle is that margin debt rose during March even as the dipped nearly 2 percent.

Margin debt is created when investors borrow money in order to buy stocks. If an investor buys $100 worth of stocks with $50 in capital, that individual has $50 of margin debt outstanding. Since margin debt provides leverage, it amplifies gains, but also increases the risk to an investor.

Margin debt tends to be highly correlated with the level of the market. Higher prices tend to spur more buying—and similarly, more buying on margin tends to spur higher prices. That's what makes the recent divergence between the S&P and margin debt levels notable.

But rather than interpret it as a sign that market sentiment is getting frothy, Erin Gibbs, S&P Capital IQ's equity chief investment officer, says it's actually a good sign.

Looking at a long-term chart comparing the S&P 500 and margin debt, "We definitely see that sentiment starts to turn first, and then we see the market go down," Gibbs said. "So I'd be more worried about margin debt being lowered and seeing a downtrend than seeing new highs. New highs don't concern me."

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And Todd Gordon of says that if anything, the savviest investors are the ones who use margin.

"It's the institutions and professional traders who trade with more capital than they already have," Gordon said. "I take this as [an indication that] institutions have established long positions, they're invested. And now we're simply waiting for the people who don't trade on margin—which is everyday investors—to come into the market. I think that's what's been missing in this advance."

Of course, not all traders use measures like margin debt to help them determine their next maneuver.

"It's one of those things, like the put/call ratio, that's only the tip of the iceberg," said Dennis Davitt of Harvest Volatility Advisors. "Plus, I only know what I have in my pocket. If I start trading based on what I think other people have in their pocket, then what am I really doing? I'm no longer investing, I'm speculating."

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