Two major indices hit highs this week … can it keep going? … one indicator that suggests traders are gearing up for more gains

If you’ve been invested in the Dow or S&P, you probably haven’t lost much sleep over the last two months.

However, if you’ve been a tech investor, you’ve probably suffered a few uneasy moments, and perhaps considered taking some chips off the table.

Below, we look at all three major indices since mid-February.

While the Dow is up 5% and the S&P is up 2% (both setting all-time highs this week), the Nasdaq is still down 4% after having dipped into correction territory several weeks ago.

But this shortened trading week was a good one for tech stocks. For the entire market, for that matter.

However, the question now is whether it just a temporary upward spike within a broader topping-out process in the market, or if the gains will keep coming.

Today, we’re going to look at a key piece of evidence that suggests “more gains.” We’ll look into this with the help of our technical experts, John Jagerson and Wade Hansen, of Strategic Trader.

In their investment service, John and Wade combine options, insightful technical analysis, and market history to trade the markets, whether they’re up, down, or sideways. This means they frequently analyze all sorts of indicators, ratios, and chart patterns to suss out clues about where the market is headed.

In their update from Wednesday, they highlighted one important indicator that suggests traders are gearing up to push the market even higher.

Let’s see what it is.

 

***Forget “March Madness,” John and Wade have been watching “Margin” Madness

From the Strategic Trader Wednesday update:

We are always looking for confirmation of trader sentiment on Wall Street.

If we can confirm traders are bullish, we feel more confident in our bullish outlook.

On the other hand, if it looks like traders are becoming increasingly bearish, we feel more confident in our bearish outlook. After all, traders drive prices …

One of our favorite ways to see just how bullish traders are is to look at how much money traders are borrowing to buy the stocks they are trading.

To make sure we’re all on the same page, we’re talking about margin debt.

John and Wade explain that traders can borrow up to 50% of the purchase price of a stock according to Regulation T of the Federal Reserve Board.

So, if a stock costs $100, traders only have to use $50 of their own money to purchase the stock. They can borrow the other $50.

This is called “buying on margin” and the amount borrowed is called “margin debt.”

Back to John and Wade:

Tracking the total amount of margin debt being used to buy stocks can give you a good sense of how confident traders are.

This is because confident traders tend to borrow more. Nervous traders tend to borrow less.

Before this past year, the highest level of margin debt Wall Street had ever seen was $668,940,000,000 in May 2018, according to the Financial Industry Regulatory Authority (FINRA).

That is a ton of money.

By the height of the coronavirus pandemic, however, margin debt had plunged back down to $479,291,000,000 in March 2020 as traders looked to reduce the amount of risk they had taken on in their portfolios.

John and Wade point out that it’s easy to understand why the S&P 500 dropped into a bear market last year when you see that hundreds of billions of dollars evaporated from the stock market.

 

***So, where is margin debt today, and what is it telling us about what traders are expecting?

Back to the Strategic Trader update:

Have traders kept their risk levels low? Have they been cautiously waiting to see if the market was going to bounce back?

Ha! No, they have not.

In fact, it has been quite the opposite.

Instead of cautiously dipping their toes back into a bullish uptrend, traders have been on the largest borrowing spree of all time.

As of February 2021, traders have borrowed a total of $813,680,000,000 to buy stocks.

 

Fig. 1 — Margin Debt Levels — Chart Source: FINRA)

 

Yes, you are seeing that right.

In less than a year, Wall Street has borrowed an additional $334,389,000,000 to buy stocks ($813,680,000,000 – $479,291,000,000 = $334,389,000,000).

For greater context, below we look at a chart comparing margin debt relative to the S&P 500. The red line shows the amount of margin debt traders are using. The blue line is the S&P.

As you can see, both the S&P and margin debt levels have exploded out of last year’s bear market.

Debt levels are now at historic highs (though they’re not at historic highs relative to the value of the S&P).

 

Source: Yardeni Research

Back to John and Wade:

Traders are incredibly bullish on the stock market right now, and they are putting their own money — plus a mountain of borrowed money — where their mouths are.

Now, it is important to note here that FINRA releases its margin debt data a month after the fact. That’s why we are just now seeing the data for February.

We’ll have to wait until the last week in April to know what the March numbers look like, but we expect to see the current trend continue.

 

***Is this a sign of market excess?

If traders are borrowing historic amounts of money, how risky is that? And might it be a sign of the kind of hubris that precedes a crash?

You could make that argument. Anytime investors add risk exposure by increasing their margin, it heightens the potential for an amplified wipeout.

That said, some analysts suggest margin levels need to be viewed in context. Specifically, if the market is making lower highs as margin levels are topping out, that’s potentially a sign of trouble. But if rising margin levels are coinciding with higher highs in the market, that can be a sign of bullishness.

On this point, I’ll repeat that both the Dow and S&P 500 set record-highs this week, and the Nasdaq sits just 4% below its record.

Here’s John’s and Wade’s take:

Seeing traders load up on so much margin debt gives us confidence that the current bullish uptrend still has legs.

It has some built-in risk as well with that amount of debt, which could lead to faster selloffs when they eventually come. But for now, we like what we are seeing.

Wrapping up, this latest clue from traders suggests the professional money expects more gains to come. Though massive levels of margin debt might turn into pain later, for now, it looks like markets will keep grinding higher.

We’ll keep you updated here in the Digest.

Have a good evening, and a wonderful Easter weekend,

Jeff Remsburg