Analysis: Do margin debts signal a US correction?

Hinesh Patel, strategist in OMGI’s fixed income and macro department, says: “Herein lies our main concern. If ‘borrowed money’ is now the marginal driver for the S&P 500 index, then we need to be braced for additional volatility going forward.”

OMGI is also concerned by Japan, but more sanguine on Europe. In Japan, OMGI’s analysis shows a ‘borrowed money’ equivalence to 8 per cent of the Topix index at the end of January 2014 –off the 2000 and 2006 highs of 11 per cent, but still significant.

Mr Patel says: “We see this flow as having been driven by foreign money in expectation of ‘Abenomics,’ rather than domestic participation. In Europe, we think there has been ‘real cashflow’ into domestic equity markets.”

So what should investors be doing? Mr Lamont believes the big issue is whether or not corporate earnings are strong enough to support current levels and further rises in an already expensive market, adding that investors exposed to US equities have done well and should now diversify internationally.

He says that given the S&P 500 index’s 29 per cent rise last year with only 5 per cent earnings growth, investors are betting on a strong acceleration in corporate profits.

“Investors wanting to add exposure to the S&P 500 today, need to have confidence that earnings growth is going to accelerate,” Mr Lamont suggests. “If they lack this confidence, they should be looking to add exposure to alternative, cheaper markets.”

Mr Moskovit says investors should take a long-term view and realise there is still a huge amount of pent-up demand globally.

Mr Patel sees US fundamentals as remaining attractive and that the US has the best possibility to achieve “escape velocity.” He attributes this to the energy independence story, stronger corporate balance sheets and that, for the first time, in many earning seasons, there are both “dollar in till” and “dollar in pocket” upside surprises, providing solid investment foundations. That said, he believes extraordinary factors, including margin debt, provide reasons to be cautious, such as monetary policy uncertainty and weather-impacted economic data.

Mr Patel says: “We prefer to hold absolute return funds to gain market exposure and to help reduce volatility and dampen downside potential.”

So what are fund managers doing themselves? BlackRock says it continues to invest in US companies, but selectively, and that outside the US, it sees more attractive relative valuations in other developed markets, such as Europe.

OMGI thinks 2013 marked a transition from ‘cheap money’ to ‘real money’, which has ramifications for global financial markets. This could mean that in the next phase, in spite of a better growth environment, investors may see all risk assets struggle as markets re-price interest rate risk.