If you don’t know what margin debt is, it’s basically borrowing to invest. It’s a way to use your investments as collateral in order to borrow from your broker and buy more shares of a given company. Sometimes it is referred to as trading on the margin and if you want to know more about it there is tons of information online. Although, knowing my views on debt you’ve probably already guessed by now my opinion of margin debt.
First off, can we even call this investing? Isn’t borrowing to invest an oxymoron in and of itself? I know these questions are beside the point but I had to ask them. The NYSE reported a few weeks ago that margin debt hit an all time high of $580.9 billion at the end of November. That is an increase of 16% in the past year.
If your like me your pulling your jaw off the floor because holy cow that is a ton of investment debt. It feels to me that the abnormal levels of volatility that we saw in 2017, and years prior to that, has lulled many investors into a false sense of security. Any kind of market pullback could put a lot of these investors into a serious pinch, aka margin call.
Market downturns are hard to predict, well hard is an understatement. It usually involves a lot of guessing and dumb luck but margin debt has foretold market declines in the past. Margin debt spiked right before the dotcom bust and the great recession. Not a good sign when you consider the amount of margin debt out there today is way higher than it was back then (about $425m before the dotcom bust and $450m before the great recession).
Who knows what the future holds. We could be in for another 20% march higher in the S&P 500 this year. After only a few days into the new year, the markets are pushing ahead as fast as ever. But no one knows the future. That is why margin debt, creating liquidity out of thin air, is so dangerous. It’s also why I refuse to even call it investing.
If markets were to go down, these levels of margin debt would force people to sell their holdings to maintain legal or broker mandated margin levels. This would accelerate the pace of any selloff, causing markets to go down further than they otherwise might. Even more disturbing, the increases in margin debt has actually outpaced the increases in the S&P 500 itself over the past few years. This has led the market to be way over leveraged as far as margin is concerned.