When is a bubble not a bubble? When the Federal Reserve says it’s not. Even if there is evidence – such as rising margin debt – to the contrary.
Fed Chair Ben Bernanke has reassured investors that monetary policy will continue benign, and that his agency will go on making purchases of long-term securities to keep interest rates low. Markets have responded with predictable enthusiasm – the S&P 500 is up 18 percent so far this year - even as the fundamental underpinnings of the rally weaken. Earnings gains, which arguably have accounted for the remarkable run-up in stock prices over the past several years, have begun to slow as revenue growth deteriorates.
Recently, a record number of companies have revised earnings lower--specifically, 87 S&P 500 companies have revised second quarter results down while only 21 have raised guidance. According to Ronald Bohlert of the NYSE, “Back in March (according to Factset) the Q2 earnings growth rate for the S&P 500 was projected to be 4.2 percent. However, after several revisions, that number has come down to 0.7 percent.” As Bohlert points out, it is worrisome that the stock market has all but ignored these downgrades: “Even the market reaction to those companies issuing positive EPS guidance has been average in terms of price change.”
It is, however, revenues, which are now expected to be flat in the second quarter, that are truly disappointing. Some 80 percent of companies that have projected revenues lately have lowered expectations – a trend that has persisted for a number of quarters. (Google and Microsoft, both of which missed revenue targets, are not outliers here.)
Consumer income and spending growth are not providing the kind of acceleration in revenues that would justify further substantial market victories. Currently, there is no ramp-up or basis for optimism, in sight. In fact, most economists have been lowering their GDP forecasts. That should give investors pause, despite Bernanke’s calming message. It should also drive them to question the impact of our endless quantitative easing.
In a recent address to the Exchequer Club in Washington, Fed Governor Sarah Bloom spoke in scholarly fashion about how asset bubbles form. Behind the “story of asset bubbles” she said, “there is usually explicit and purposeful financial institution involvement.” She goes on to paint the backdrop of an emerging bubble as colored by “interest rates that have been low…for a long time”, the search by retail investors for higher yield, and ultimately higher debt levels to leverage yields.
She fleshes out this picture by noting that banks and other lenders may increase their borrowings to supply credit to investors, fueling greater asset price increases, creating an in-virtuous circle.
There’s more, but you get the picture. Now, consider what has been happening to margin debt. Last May (the latest available), margin debt in the accounts of New York Stock Exchange member firms totaled $377 billion, slightly off the prior month total of $384 billion but up 35 percent year-over year. The April figure was the highest since 2007, when it surpassed $420 billion.
In a piece for Business Insider, Doug Short shows the close correlation between market moves and margin debt. He suggests that typically a downturn in margin borrowing narrowly precedes or is coincident with market retreats. That was the case in 2000 and again in 2007, after a surge in borrowing.
In those two years, and also today, customers had negative credit balances, calculated by adding free credit cash accounts and credit balances in margin accounts and subtracting out the debt. In April, NYSE customers were more than $100 billion in the red – as they were back in 2000 when the fellow parking cars and his neighbor the house painter were up to their elbows in tech stocks.
Market gurus tell you not to fight the Fed, and they’re probably right. Still, it’s hard to ignore the bubbles floating out of Bernanke’s magic wand.
