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A Subjective Perspective On US Stocks

Sebastião Buck Tocalino,
June 1, 2015

  • Over half-a-trillion in margin debt laid on top of a staggering 6+year-long bull market in stocks surely sounds like a lot of optimism.

  • Stocks and leverage keep soaring, despite the worst global financial crisis since the great depression and the slowest economic recovery ever!

  • If an appropriate perspective for viewing the S&P500 cannot rely on new endogenous strength in the economy, where must we draw perspective from?
  • I used to draw a lot when I was growing up. My thoughts would travel on overdrive while I sketched to the sound of classic rock on vinyl. It was an introspective activity, nevertheless very entertaining.

    I don't remember how old I was when my mom first taught me the cool trick of perspective. She showed me how I could draw some straight guidelines reaching out from one or more points on the horizon to achieve more realistic angles and outlook. It was both effective and enlightening! But, after some interesting trials, I resigned back to the old-fashioned and more childish approach: sheer intuition. Undoubtedly, I was more seduced by the freedom I felt in sketching than the possibility of obtaining better graphic representations. After all, I was just a kid.

    Still, thanks to my dear mother, the notion and importance of perspective was forever ingrained in my mind. Focal points may avoid distorted pictures and silly-looking images at the end. Though I rarely drew those lines or marked the points on the paper, I would try to keep a mental picture of them.

    When drawing an urban scene, each street must have guidelines converging to the horizon. The more complex the picture, the more we need these lines to achieve better perspective.


    So, even art cannot rely on intuition alone. We need to set and follow guidelines for almost everything. Obviously, Wall Street is no exception, even if metaphorically speaking. A lack of perspective may induce distorted views and problems ahead! But finding reference points for the economy and markets may be less straightforward than the basic geometry depicted above.

    Some of us still wonder how stock indices can just keep climbing higher and higher to new record levels when we had the worst global financial crisis since the great depression and we are yet struggling through the slowest economic recovery ever! The actual picture of the U.S. stock market, against the current economic backdrop, just seems out of whack and surreal - like some sort of optical illusion.

    Is this crisis a figment of our collective imagination? Are things much better than some of us portray them? Is this really a secular bull market and lots of people are just missing out on a still great opportunity?

    Well, my view is that the crisis was and continues to be very serious, while the recovery has been indeed very sluggish and, by no means, guaranteed yet. In spite of that, when it comes to this bizarre bullish trend in the stock market, it is impossible to answer how far in time or how high in levels it can still reach. But, to my credit, I did expect further leverage in stocks.

    In April, I wrote: "Total margin debt at the New York stock exchange has just set another record high, at $ 476 billion dollars! (...) I do believe margin debt is likely to spike up higher and closer to $ 550 Bil."

    It seems to be playing out. If that former record of $ 476 billion (for March 2015) wasn't astonishing enough in the midst of this dreadful crisis/recovery scene, the heavy betters just snubbed that cipher and raised their bets. Total margin debt grew 6.5% in April alone! It registered the jaw-dropping total of $ 507 billion dollars, as the NYSE market data release indicated last Friday (May 29, 2015).

    NYSE total margin debt x S&P500

    Over half-a-trillion in margin debt laid on top of a staggering 6-plus-year-long bull market in stocks surely sounds like a lot of optimism for anyone's standards and by any measurement, let alone in this economic environment!

    This is not like some college party where few inconvenient drunkards insist on not leaving the already depressing scene; it looks more like some new party-hogs are crashing in and bringing more booze with them, boasting in a loud chorus: Let the good times roll!

    But, if the past is any clue, the stock market reversals of 2000 and 2007 suggest that these parties just get louder and wilder for months before they actually end. Just pay attention to the chart above and the margin debt patterns I have highlighted in red.

    At the risk of being called a killjoy and party-spoiler, I would like to apply a little bit of my mom's drawing tip to this stock market.

    The S&P500 is normally presented like this:


    But, if an appropriate perspective for viewing the S&P500 chart cannot rely on any new endogenous strength of the economy, we can certainly find a much better reference for it in the total assets purchased and held by the Federal Reserve System.

    S&P500 and FED balance sheet

    Before the collapse of Lehman Brothers and the deflagration of the Global Financial Crisis in 2008, the ebb and flow of the stock market seemed independent from the FED's balance sheet. But things have changed!

    So let us keep that in mind while we redraw the stock market in a different perspective, focusing on the FED's balance sheet. In the chart below, I divided the value of the S&P500 index by the trillions of U.S. dollars in total assets held by the FED. We could also use the monetary base for that matter, with very similar results:

    S&P500 adjusted to the FED balance sheet

    The extraordinary monetary policies adopted around the world should be enough to show us that global fragility is still very real and scary. This has never been just an ordinary or temporary crisis. All these palliative treatments from central banks are not really curative. There is a difference between treating the symptoms of a disease and effectively treating its causes. Money printing has eased many of the financial symptoms of this sick economy, but it did not rid us of the real pathogens: namely, too much debt and changing demographics! If central banks can do something about debt, that is certainly more in terms of prevention than remediation. And they are completely powerless against demographics!

    If the Japanese lessons were not educational enough, perhaps the more recent practical experiments in the U.S. and Europe will finally set straight the economic theory for the benefit of future generations.

    No matter how advanced the nation and the economy, there must always be some limit to credit expansion and population growth. But do we need any PhD in economics to figure that out?

    So prick up your ears, people of the world!


    Copyright © Sebastião Buck Tocalino - All rights reserved.

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