As you can see in the chart above, the year-over-year growth in margin debt as a percentage of market capitalization declined as well in July. On a year-over-year basis, margin debt declined by 0.5% during the month, which is the first year-over-year decline since February 2020 and is well below the recent high of 36.8% that we saw in January 2021.

Given the fact that margin debt fell notably during the month and that margin debt declined on a year-over-year basis, we have left this signal at yellow for now. While the improvement during the month was encouraging, the overall high level of debt is still a concern for the short-term; however, further declines in the months ahead could lead to an upgrade to green.
Signal: Yellow light

Risk factor #3: Technical factors. A good way to track overall market trends is to review the current level versus recent performance. Two metrics we follow are the 200-day and 400-day moving averages. We start to pay attention when a market breaks through its 200-day average, and a break through the 400-day often signals further trouble ahead.

Technical factors remained supportive for equity markets throughout August. The S&P 500, which managed to break above its 200-day moving average at the end of May 2020, finished above trend every month since. This marks 14 consecutive months with all three major U.S. indices finishing above trend.

The 200-day trend line is an important technical signal that is widely followed by market participants, as prolonged breaks above or below could indicate a longer-term shift in investor sentiment for an index. The 400-day trend line is also a reliable indicator of a change in trend. The continued technical support for markets in August was encouraging, so we have left this signal at a green light.
Signal: Green light

Risk factor #4: Market complacency. This is a recently added risk factor that aims to capture a standardized measure of market complacency across time. Complacency can be an uncertain term, so this chart identifies and combines two of the common ways to measure complacency: valuations and volatility.

For the valuation component of the index, we are using the forward-looking price-to-earnings ratio for the S&P 500 over the next 12 months. This gives an idea of how much investors are willing to pay for companies based on their anticipated earnings. Typically, when valuations are high, it signals that investors are confident and potentially complacent. For volatility, we have used the monthly average level for the VIX, a stock market volatility index. When volatility for the S&P 500 is high, the VIX rises, which would signal less complacency.

By combining the two metrics in the chart below, we see periods where high valuations and low volatility have caused peaks, such as 2000, 2006–2007, and 2017. We saw market drawdowns within roughly a year following each of these peaks.