Margin debt has been on the rise. That means risk to the stock market is increasing, a danger that has worsened as share prices have fallen recently.
Margin debt—the amount of money traders have borrowed to buy new shares, using their stockholdings as collateral—has hit a level close to an all-time high. It’s at $936 billion, according to Yardeni Research, up 40% from this time last year.
Using margin debt can amplify returns on an investor’s cash because a trader can hold a bigger position using the same amount of their own money. But the same is true on the downside. If the share prices fall, the investor—saddled with debt—sees his or her portfolio value plummet more than it would have otherwise.
The rising amount of debt is concerning, but more worrisome is the percentage of the stock market’s value that the debt represents. Margin debt is currently 2.4% of the
‘s aggregate market capitalization of $38 trillion. Just before the pandemic, it was at roughly 2%. To be sure, the current level of margin debt relative to the stock market’s value is still below its high, the 3.5% that it reached around the time of the 2008-2009 financial crisis. The lowest point since the mid-1990s was below 2%.
In any event, the combination of rising margin debt and slipping stock prices augments the risk to the market. When the value of the shares a trader purchases on margin falls to a certain point, the broker that lent the money demands that the trader deposit additional cash in the account. Either the trader has the money available, or he or she must sell stocks to raise the cash.
If the stock market falls enough, many traders will receive margin calls, which could force even more selling that would drag prices down. “Margin is at a record high,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “That increases the possibility of more margin calls if we get more [market] weakness.”
That risk to the market is certainly higher than it was just a few weeks ago. The S&P 500 has fallen about 3% from the record level it hit in November, hit by uncertainty over how well existing vaccines will work against the Omicron variant, not to mention word from the Federal Reserve that it may end the bond buying it has used to support the economy sooner than planned.
A stock market moving downward is often a reason to buy. This time, it could be a sell signal.
Write to Jacob Sonenshine at [email protected]