Tag Archives: Margin

Stock Markets Sit Blithely on a Powerful Time Bomb, by Wolf Richter

Posted on April 22, 2017 | Leave a comment

Speculators on margin add to stock market volatility, because their creditors can force them to either cut their positions or cough up more money when prices go against them. From Wolf Richter at wolfstreet.com:

No one knows the full magnitude, but it’s huge.

How big is margin debt really, and how much of a threat is it to the stock market and to “financial stability,” as central banks like to call their concerns about crashes? Turns out, no one really knows.

What we do know: Margin debt, as reported monthly by the New York Stock Exchange, spiked to another record high of $528 billion. But it’s only part of the total outstanding margin debt – which is when investors borrow money from their broker, pledging their portfolio as collateral.

An example of unreported margin debt: Robo-advisory Wealthfront, a so-called fintech startup overseeing nearly $6 billion, announced that it would offer its clients loans against their portfolios.

“The dream house. The dream wedding. The dream kitchen. The dream vacation.” That’s how it introduced it in a blog post this week. “We want you to have your cake and eat it too,” it said.

Instant debt “without the hassle of paperwork,” it said. “We want our clients to be able to borrow what they need, when they need it, directly from their smartphones.” Secured by “your own investments.”

It’s a great deal as long as stocks are soaring. Clients with at least $100,000 in their account can borrow up to 30% of the account value. It’s seductive: No required monthly payments and no payoff date, though interest accrues and is added to the monthly balance. The rate is as low as 3.25%. “How’s that for flexibility?” it says.

That’s how margin debt is being pushed at the end of the cycle.

This borrowed money can be drawn out of the account to fund vacations or a down-payment of a house. But when stocks spiral down, as they’re known to do in highly leveraged markets, and fall below the margin requirement, clients get a margin call. They either have to put cash into the account to make up for the losses or they have to start liquidating their portfolio at the worst possible time.

To continue reading: Stock Markets Sit Blithely on a Powerful Time Bomb

 

Leave a comment

Posted in Debt, Financial markets

Tagged ,

Stocks Were Already Crashing the Last Two Times this Happened. So What Gives? by Wolf Richter

Posted on July 26, 2016 | Leave a comment

High-flying stock markets are usually kept aloft by margin debt. What happens when margin debt starts to contract? From Wolf Richter at wolfstreet.com:

The foundations have crumbled. All bets are off.

Over the last 20 years, margin debt – when investors buy stocks with borrowed money – went through three multi-year run-ups, each topped off with a spike, followed by a reversal and decline: during the final throes of the bubbles in 2000 and 2007, each followed by an epic stock market crash – and now.

That pattern of jointly soaring and then declining margin debt and stocks even occurred during the run-up and near-20% swoon in 2011.

The grand cycle began in February 2009, at the trough of the Financial Crisis, when margin debt had dropped to $200 billion. It was followed by a multi-year record-breaking run-up, topped off with a spike that culminated in an all-time peak of $507.2 billion in April 2015. Then margin debt reversed and began to decline. On cue, the stock market began to decline a month later. Margin debt zigzagged lower, and stocks did too. But in February this year, stocks suddenly bounced off sharply – without margin debt.

The New York Stock Exchange reported on Monday that margin debt declined again in June, by $3.7 billion to $447.3 billion, just a hair above where it had been in February.

This chart by Doug Short at Advisor Perspectives overlays margin debt and the S&P 500 from 1995 through the end of June. The data is expressed in today’s (“current”) dollars to eliminate the impact of inflation. Even adjusted for inflation, margin debt and the S&P 500 hit a record high in April 2015. By the end of June 2016, the S&P 500 was again at a record high, but margin debt had dropped 12%. That divergence (red arrow) hasn’t happened for at least the past four decades:

There’s a reason for this relationship. Margin debt is the great accelerator for stock prices, on the way up and on the way down. When investors buy stocks with money they don’t have and that the broker creates for them, it drives up stock prices, and these higher prices allow investors to borrow more money against the same number of shares, which drives up share prices further. Leverage is a wonderful mechanism to create demand.

But when stocks tank, spooked investors begin selling stocks and pay down their margin debt. They’re deleveraging, taking risk off the table. If stocks fall sharply, investors may be forced to sell – or the broker will do it for them at the worst possible time – to pay down their margin debt to stay within the margin limits. Forced selling drives down prices further, which begets more forced selling. And prices spiral lower.

As the chart shows, margin debt has a nerve-racking habit of peaking right around the time stocks begin to crash. In March 2000, margin debt hit a record of $278.5 billion (actual, not adjusted for inflation), just as stocks had begun to crash. A few years later, with the crash having faded from memory, margin debt spiked again, peaked at $381.4 billion (actual, not adjusted for inflation) in July 2007, and fell off. A few months later, stocks sold off. That sell-off eventually turned into a blistering rout.

To continue reading: Stocks Were Already Crashing the Last Two Times this Happened. So What Gives?

Leave a comment

Posted in Debt, Financial markets, Uncategorized

Tagged ,