In an investment environment where nothing matters anymore – until it suddenly does.
Through Wolf richter for WOLF STREET.
In the current craze that encompasses everything from sneakers and NFT to stocks, where valuations don’t matter because of the widespread certainty that valuations will be even higher in a few days, and where people are looking for lottery-like returns, backed by the crackdown on interest rates from the Fed and $ 3 trillion in asset purchases, and government billions of dollars in donations and bailouts – well, in this perfect world there’s a fly in the ointment: vast amounts of leverage, including stock market leverage.
Margin debt – the amount that individuals and institutions borrow on their equity holdings according to FINRA’s tracking of its member brokerage firms – is only one indication of stock market leverage. But FINRA reports it every month. Other types of stock market leverage are either not reported at all, or are only disclosed on an ad hoc basis in SEC filings by brokers and banks that lend to their clients on their portfolios, such than securities-based lending (SBL). No one knows how much total market leverage there is. But margin debt is showing the trend.
In February, margin debt jumped another $ 15 billion to $ 813 billion, according to FINRA. Over the past four months, margin debt has climbed $ 154 billion, a historic leap to all-time highs. Compared with February of last year, margin debt skyrocketed by $ 269 billion, or nearly 50%, for another WTF sign that the zoo has gone mad:
But margin debt doesn’t come cheap, especially small amounts. For example, Fidelity charges 8.325% on margin balances below $ 25,000 – in an environment where banks, money market accounts, and treasury bills pay close to 0%. Margin debt becomes cheaper for larger balances, an incentive to borrow more. For margin debt of $ 1 million or more, Fidelity’s interest rate drops to 4.0%
“Whether you need extra cash for short-term financing or to buy more securities, a margin loan can help you get the money you need,” Fidelity says on its website. In other words, take out a margin loan to buy a car or some much-needed bitcoin or NFT.
Each broker has their own margin interest rate schedule. Morgan Stanley charges 7.75% for margin balances less than $ 100,000, compared to 6.875% for Fidelity for balances between $ 50,000 and $ 99,999. For margin balances over $ 50 million, Morgan Stanley charges 3.375%.
And it is risky leverage for the borrower. It seems like risk-free leverage when stocks go up, but when your stocks hurt and fall below a certain level, your broker will ask you to put more money in your account or sell stocks on. the tanking market, which will then allow you to join the legions of forced sellers.
In the past, a sharp increase in margin balances tended to precede historical declines in stock markets:
Over the two-decade period of the graph, the long-term changes in dollar amounts are smaller as the purchasing power of the dollar vis-à-vis stocks has fallen.
But in the short term, the changes show what happens to margin debt in the lead-up to the sale, and what happens during the sale when margin demands turn investors into legions of forced sellers.
Leverage is the great accelerator of stock prices, both up and down. Buying stocks with borrowed money creates buying pressure, and prices rise, and rising prices increase the margin balances a portfolio can support, which encourages more buying of. margin actions.
On the other hand, selling stocks to deal with margin calls adds increased selling pressure in an already declining market. The more the prices fall, the more exhausted forced sellers try to keep up with the margin demands on the sale.
Then, at a magical moment, the margin debt has been sufficiently reduced and its contribution to selling pressure fades.
The historic surge in margin balances in recent months is another indicator of how hyper-speculative and blindly brave the mega-bubble has become. All kinds of new theories are being put forward as to why fundamentals and valuations don’t make sense, and why all asset prices will shoot the moon no matter what.
These theories have run into bloodshed in high-quality treasury bills and corporate bonds with longer maturities as long-term yields have been rising for months, which I discuss in my podcast. . THE WOLF STREET REPORT: Market fads galore, but long-term interest rates smell like a rat
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