While the stock market continues to defy all odds, it is beginning to reveal cracks in its foundation. Wall Street gamblers have been rolling the dice using borrowed money at record levels to fuel this market.
In the following chart the red line depicts the amount of money investors have borrowed to buy stocks while the blue line depicts the S&P 500.
In November, margin debt reached $424 Billion. This falls within 1% of the inflation adjusted all time high which preceded the market crash of 2007 and is well past the high achieved just prior to the 2000 crash.
Click on Chart to Enlarge
So why is high margin debt so dangerous? Investors who borrow money to buy stocks must pay interest on these loans just like any other type of loan. If the market doesn’t continue to climb faster than the cost of the loan, these investors will begin selling the shares they own “on margin”. To make matters worse, margin debt is secured by the stocks owned by the investor. If the market begins to decline, the value of the stocks securing the debt decline as well. When the stocks in the investor’s portfolio no longer support the loan requirements the margin debt is “Called” by the lender. At this point the investor must deposit more cash or sell the stocks. In a falling market this can create an uncontrollable chain reaction. The higher the overall margin debt the bigger the potential chain reaction.
For a more in-depth analysis of margin debt go to:
By Doug Short
December 30, 2013