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Maximum investor leverage could signal stock market weakness going forward as traders begin to reduce risk, BofA says

  • A potential spike in margin debt could pave the way for a bearish stock market, according to BofA.
  • FINRA’s margin debt fell 4% to $ 844 billion in July, even as stocks rose 2.3%.
  • “While peaks in margin debt don’t always coincide with highs in the S&P 500, they tend to be bearish for stocks,” BofA said.
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A potential spike in investor leverage could pave the way for a bearish stock market in the future, Bank of America said in a note Tuesday.

Investors recently reduced the risk to their portfolios, as FINRA’s margin debt fell 4% from a record $ 882 billion in June to $ 844 billion in July. Meanwhile, stocks rose 2.3% to all-time highs in July.

“Rising leverage tends to confirm the rally in US equities. It is not the new record high margin debt that we are concerned about. We are concerned when margin debt stops rising to suggest that investors have started reducing debt, “said Stephen Suttmeier, technical research strategist at BofA. .

Using various data sources, BofA found that since 1928, a spike in margin debt has led the S&P 500 to generate a negative one-year return 71% of the time, with an average return of -7.8% and a median return of -10.7%.

“While peaks in margin debt don’t always coincide with highs in the S&P 500, they tend to be bearish for stocks,” Suttmeier said.

But the worrying technical signal of a peak in margin debt could be canceled if FINRA’s margin debt recovers quickly and surpasses June’s all-time high. The S&P 500 is up around 2% in August and up nearly 5% since the end of June.

“If June 2021 turns out to be a cycle peak for margin debt, it would coincide with the start of the weaker part of the presidential cycle. It could provide a healthy break in a larger secular bull market, especially after the fastest 100% S&P 500 rally since the 1930s, ”concluded Suttmeier.