Margin Debt & Stock Market Returns

I ran a little experiment to see how the growth or decline of NYSE margin debt correlates with stock market returns. Before conducting the experiment, I expected that high rates of margin debt growth would mark periods of speculative excess, and therefore result in low future stock market returns.

The average 1yr rate of margin debt growth on the NYSE since 1959 is 11.18%.

For my experiment, I calculated rolling forward 2yr cumulative returns on the S&P 500 for all periods since 1959. Next, I divided the periods since 1959 into ‘above average’ and ‘below average’ margin debt growth groups.

Here are the results:

1. Average 2yr stock market return after all periods: 22.97%

2. Average 2yr return after periods with below average margin debt growth: 23.27%

3. Average 2yr return after periods with above average margin debt growth: 18.72%

Bottom Line: the results illustrate a moderate-to-weak relationship between above average margin debt growth and below average future stock returns.

Incidentally, 2yr returns after margin debt grew by 40% and 60% were 6.97% and 6.7% respectively. This supports the thesis that above average margin debt growth leads to below average stock market returns. However, it also shows that the relationship is not linear since the stock market returns stopped declining by a meaningful degree after margin debt growth surpassed 40%. Further clouding the relationship, there also were periods (e.g. 1983) with very high margin debt growth and double-digit stock market returns.

How fast is margin debt growing today? For the 12mths ending December 2009 NYSE margin debt grew by 23.66%. But given the results of my experiment, I wouldn’t rely on margin debt growth to anticipate future market returns.