Stock market chars that show the amounts investors used to finance stock purchases, on a margin appear, to be one of the indicators of a predictable recession.
The following charts shows the % of purchases done on the basis of margin debt vs. GDP.
The current levels of margin have now exceeded the recession peaks in 2000 and in 2007. Such high levels suggest that current levels of investment that is based on d low interest rates may not be sustainable for much longer.
The sums of money that support current trading with borrowed fund is indicated in the following chart showing dollar amounts:
This chart indicates the margin debt now exceeds $642 Billion. This debt has grown by over $400 billion since the last recession, where it may ultimately revert to comparable levels.
Another indication of a prospective break in the prices of equity is the increasing decline in the profitability of the stock market. That is best indicated in the following:
The Schiller implied returns from the stock market have now declined to negative returns (e.g. -1.7%) which suggests that the valuation of invested shares has ceased to be attractive because the prices paid are now excessive.
One of the most frequently used indications of the overall soundness of a stock market is the Price/Earnings (P/E) ratio of any stock, fund or all investments. This is best indicated in the following long-term chart:
The P/E ratio used in this illustration is the cyclically adjusted price-to-earnings ratio, commonly known as CAPE or Shiller P/E. It is a valuation measure applied to the US S&P 500 equity market and defined as the price divided by the average of ten years of earnings (moving average), adjusted for inflation. This is principally used to assess likely future returns from equities over timescales of 10 to 20 years, with higher than average CAPE values over 16 implying lower than average long-term annual average returns.
It is noteworthy that the current value of CAPE is 33.6, which is materially over its average and clearly higher than its peak in the 1929 and 2000 recessions. The cyclic characteristics of this ratio suggest a high likelihood the a recession will follow on account of the excessive levels of stock prices as compared with earnings.
We have shown three indicators that suggest an incipient recession.
The first indicator shows a high level of margin debt relative to GDP. This indicates that an unusually large amount of low-priced capital is getting diverted into the stock market and getting applied to wealth-creation assets.
The second indicator that the expected returns from the stock market are now negative. This indicates that the prices paid for investments are now too high as compared with their profit-making capacity.