Few took the warning seriously that margin debt issued last year.
By Wolf Richter for WOLF STREET.
There is a huge amount of leverage out there, and most of it is hidden until it blows something up. The Fed encouraged leverage through interest rate repression and QE, and folks took that encouragement and piled into it. Some of this leverage is already blowing up with spectacular results, such as the leverage in the crypto world. In the stock market, leverage takes multiple forms. But only margin debt is reported and known, it’s the only visible part of stock market leverage – the tip of the iceberg. And it’s associated closely to “stock market events.”
In June, margin debt plunged by $69 billion from May, the second-largest month-to-month plunge ever, behind only the $80 billion plunge in January, according to Finra, based on reports from its member brokers. In percentage terms, margin debt plunged by 9.2%. This type of percentage drop is invariably associated with the biggest stock-market sell-offs, as we’ll see in a moment.
At $683 billion in June, margin debt was down by $252 billion, or by 27.5%, from the peak in October 2021 ($936 billion). The Nasdaq peaked in mid-November and has since sold off by nearly 30%. The S&P 500 peaked at the beginning of January and has since sold off by nearly 20%.
This chart is an indicator of the gigantic levels of risk taken in 2020 and 2021 through ballooning leverage – with margin debt being just the visible tip of the iceberg. Starting in November, it became an indicator of the turmoil in the market. And now, it’s an indicator of a huge amount of leverage still left to unwind.
Financial market “events” and 9%+ drops in margin debt.
The month-to-month percentage-drops that had been nearly as big or bigger than June’s 9.2% plunge all occurred during financial market events, going backwards in time:
- Covid crash, March 2020, margin debt: -12.1%
- Euro Debt Crisis, August 2011, margin debt: -10.4%
- Financial Crisis crash, margin debt drops:
- August 2007: -13.0%
- October 2008: -19.7%
- November 2008: -18.1%
- May 2010: -9.1%
- Dotcom crash, margin debt drops:
- April 2000: -10.4%
- December 2000: -11.6%
- March 2001: -12.1%
- October 1987 crash…
The October 1987 crash... Just for fun. The margin debt data I have access to goes back to 1990. So it does not include margin debt levels in the run-up to the spectacular crash in October 1987, when the S&P 500 collapsed by 32% in 10 trading days, including the 20.5% plunge on October 19 (Black Monday). And there was a record amount of margin debt before the sell-off and a record amount of margin calls and forced selling during the crash that accelerated the crash.
That’s what leverage does: it drives up prices before, and it drives down prices during the sell-off. Leverage is the great accelerator, in both directions.
The numbers were minuscule compared to today’s Fed-encourage leverage binge and after 35 years of inflation. From the archives of Los Angeles Times, which is kind of cute today, I mean, 44 lousy billion…
“Margin debt at the end of September had ballooned to a record $44.17 billion, double the $22.47 billion at the end of 1984 and quadruple the $10.95 billion five years ago, according to the New York Stock Exchange. More than 2.8 million investors have margin accounts, with the average account size growing to more than $4,880, up from $1,415 in mid-1984, when the NYSE first started tracking them.”
The LA Times also reported in the same article about some of the side effects of leverage blowing up, and that’s not so funny anymore:
“On Monday [Black Monday], a distraught Miami investor – reportedly facing a margin call – shot and killed the branch manager of his brokerage office and critically injured his broker. The investor then killed himself.”
Brushing aside the margin debt signals.
Ballooning amounts of stock market leverage adds new fuel to the market. But vanishing amounts of leverage not only removes that fuel to be poured on the market but pours water on the fire, when investors get spooked and sell stocks to pay down their margin debt, and when margin calls go out and forced selling kicks in.
Margin debt, when it’s ballooning, can serve as an effective warning signal about risks and issues building up in the stock market. And when it starts to decline, as it did last November, it can ring the alarm bell.
No one ever takes this warning bell seriously, and it’s loudly pooh-poohed by stock-market hype mongers who want to put margin debt charts on a log scale or adjust it to inflation or whatever, or both, in order to conceal the issues and cover up the risks.
If anyone ever tells you to put a financial chart on a log scale, such as margin debt, to make it look less scary, run!
No one took the margin-debt alarm seriously late last year. Well, maybe some people did… Microsoft CEO Satya Nadella dumped 50% of his Microsoft shares on November 22, totaling $285 million, for an average price of $349.59. On Monday, Microsoft [MSFT] closed at $254.25, down 27% from his average sales price. He’d saved himself $80 million so far.
When a market gets whipped to ludicrous levels, it pays to get out. Hundreds of hype and hoopla stocks have by now collapsed by 70%, 80% and over 90%, and I have tracked some of them in my Imploded Stocks column.
Margin debt annotated with stock market “events.”
In terms of the warning signal of margin debt, the absolute dollar amounts over the decades don’t matter. What matters are the steep increases in margin debt before the selloffs, and the steep declines during the sell-offs. The chart below shows the relationship between margin debt and “events” in the S&P 500 index, including the current “event.”
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