By Elliott Wave International
A famous quote attributed to Archimedes, the ancient Greek mathematician, is: "Give me a place to stand and with a lever I will move the whole world." And, as you probably know, leverage can also move the stock market.
In the July-August Elliott Wave Theorist, Robert Prechter discussed the role of leverage in sending the market to new price highs.
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First, take a look at this chart from that issue, and then read Prechter’s commentary.
Margin debt, incredibly, is up 100 times in the last 39 years (see the chart above). It was $4 billion back in 1974; it’s nearly $400 billion today. That is a big reason why stock prices are in the stratosphere. You might think that there’s a lot more money around, thereby justifying the rise. … Let’s normalize this indicator to GDP and see what we have. … [M]argin debt as a percentage of annual GDP is still 10 times the 1974 level. … The current ratio is also 3 times what it was at previous major tops in the stock market in the 20th century.
— The Elliott Wave Theorist, July-August 2013
Margin debt levels are not a precise market timing indicator, but one major financial firm advises caution.
"Investors have rarely been more levered than today," said Deutsche Bank, warning that the spike in margin debt is a "red flag" and should be watched closely. … It said the equity rally may have further legs but it cited "astonishing similarities" between the latest patterns and events preceding prior market crises.
— The Telegraph, August 13
The high levels of margin debt in the stock market should be a concern to every investor, as should other indicators that Elliott Wave International reviews.
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This article was syndicated by Elliott Wave International and was originally published under the headline A Big Reason Why 2013 Stock Prices are in the Stratosphere. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.