Margin Debt Is Declining. Are The Bulls In The Clear?

In a recent weekly newsletter, I discussed the rather dramatic decline of short-interest in the S&P 500 which suggests a high degree of complacency by investors.

As Wolf Richter recently noted:

“Of the total shares outstanding of the SPDR S&P 500 ETF, only 2.6% were out on loan to short-sellers this week, the lowest since early October 2018, and down from 7% during the summer, according to IHS Markit data cited by Bloomberg. Meaning that short-sellers who want to short the entire market, and not specific companies, are worried that the market will break out, powered by a Brexit deal or a miraculous US-China trade deal as per presidential tweet, or whatever, and rip their faces off if they’re short the market.”

In other words, optimism about the “bull market” continuing is actually rather high, despite seemingly negative sentiment from headlines.

As Wolf goes on to note, short-sellers are “speculators” in the purest form. They are also leveraged investors who have been deleveraging as of late. The chart below shows margin debt as reported by FINRA, as compared to the “free cash balance” of investors.

You can see that since May 2018, the level of “negative cash balances” has improved as margin debt has declined. However, we need to keep this in perspective as even with the recent improvement, negative cash balances are still twice as high as any other point in history.

More importantly, note the events related to increases in margin debt. Clearly, a decade of ultra-low interest rates, ongoing liquidity infusions by Central Banks, and surging levels of stock buybacks have emboldened speculators to take on ever-increasing levels of “risk” through leverage.

This deleveraging process over the last year, combined with the sharp drop in “short interest,” suggests the speculative investors have become much more cautious on the market.

However, is this more negative positioning, a contrarian signal for the markets?