Stock market margin debt spiked by $33 billion in October from September to another all-time high of $936 billion, up by $277 billion, or by 42%, from a year ago, and up by 67% from October 2019 and high levels of stock market leverage are one of the preconditions for a massive sell-off. It’s hard to have a massive sell-off without a lot of leverage.
This post by Lorimer Wilson, Managing Editor of munKNEE.com, is an edited ([ ]) and abridged (…) version of a article by Wolf Richter
Margin debt is the big accelerator on the way up, as borrowed money enters the market and creates new buying pressure and margin debt is the big accelerator on the way down, as this borrowed money gets drawn out of the market and vanishes by paying off debts, thereby creating selling pressure.
The increase in margin debt has become a huge outlier, compared to prior years, with margin debt ballooning by 42% year-over-year and by 66% in two years, summarized by this chart of year-over-year changes, with the period since March 2020 in red:
This type of stock market leverage…predicts that when this market is going down hard enough:
- it will trigger massive bouts of forced selling as margin calls are going out, and leveraged investors have to sell stocks to pay down their margin debt,
- which then pushes down prices further,
- which then triggers more forced selling,
- and more fears of forced selling, as portfolios are being liquidated,
- thereby accelerating the swoon…
Below is the long-term view of margin debt…
In its Financial Stability Report, released this month, the Fed is particularly warning about high leverage among young stock market investors saying: “The median leverage ratios of younger retail investors are more than double those of all investors, leaving these investors potentially more vulnerable to large swings in stock prices, as they have a larger debt service burden...Moreover, this vulnerability is amplified, as investors are now increasingly using options, which can often boost leverage and amplify losses.”
High leverage is a sign of high and growing “risk appetite,” as the Fed calls it and concerning the risk appetite of these investors, and their reliance on the social media, the report warns that “A potentially destabilizing outcome could emerge if elevated risk appetite among retail investors retreats rapidly to more moderate levels.”
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