Much has been made of the rising level of margin debt held by individuals. Cumulative NYSE margin debt, or the amount of money lent to buy stocks on credit, is rapidly approaching $2.3 trillion, an all time high.
Historically, when this figure peaked, and no more money was available for mom and pop to buy shares with broker loans, markets fell.
This has been put forward by talking heads, pretenders, and wanabees as a major reason why the stock market is imminently going to crash. But if you followed their advice until now you would have sat out one of the most impressive bull markets in history, or gone broke shorting against it. Follow their advice, and would have cheated yourself out of a fortune.
For a start, please note that this is a 20-year chart. The numbers have been high and rising for 18 months, and that is a very long term to be wrong about the stock market. Only TV personalities can be wrong this long, and still keep their jobs. Everyone else would have landed in the jobs section on Craig?s List a long time ago.
The harsh reality is that individuals account for such an infinitesimally small share of the market that their margin debt has become an irrelevance. Hedge funds alone account for 60% of the daily trading activity, with high frequency traders taking up a large share of this. Institutional activity, such as the large pension funds, mutual funds, and ETF?s account for most of the rest.
True individuals are somewhere in the single digits in terms of daily trading activity. Focus on their activities alone, and you are characterizing the majority with the input from a tiny minority. You see this in politics all day long. Try it with your investments, and you will lose all your money.
While there is no doubt that leverage in the markets is expanding as they rise, it is found in different areas. Modern leverage is to be found in the derivatives markets, such as in options and futures, credit derivatives, 3X ETF?s, and other esoterica. You also see it in the private deals that hedge fund custodians cut with their largest clients.
Looking at this measure, margin is at a fraction of the 2007 peak. In fact, thanks to the new regulations imposed by Dodd-Frank, many forms of securities credit are now illegal. Bank capital requirements and the prohibition of house trading assured by the Volker Rule come to mind.
Greater risk control adopted by both borrowers and lenders guarantee that far fewer are betting the ranch. Systemic risks are now virtually nil. As you may recall, excessive leverage almost brought the world to an end in 2008.
In fact hedge funds and institutions have far more credit available to them than they are using. If they really wanted to put they pedal to the metal, markets could easily soar by 50%-100% from here before they run out of dough. I think that will eventually happen before the music stops playing. But that could be years off.
If you feel like you have been lead astray by the exaggerated importance of margin debt, don?t worry, you are not alone. One of the many reasons that the Federal Reserve missed the severity of the Great Recession early on was that they thought that margin debt was reasonable, given the larger market capitalization of the financial system.
They were completely unaware that new, highly toxic forms of leverage had been invented since the last bear market and recession that could wipe out every financial institution on the planet. They found out the truth the hard way.
Make sure you don?t. Reliance on antiquated data sets can be hazardous to your wealth. Don?t fall into this backward looking trap.
