There are other types of stock market leverage, and no one knows how much leverage there is in total. Margin debt is the only indicator reported.
By Wolf Richter for WOLF STREET.
Margin debt — the only type of stock market leverage regularly reported — fell another $36 billion, or 4.3%, in March from February, and 12.4% over the three months, at $800 billion, according to FINRA, which collects this data from member brokers. Margin debt has now fallen below the level of a year ago. But the leverage is still gigantic and still has a long way to go.
After peaking in October at $936 billion, margin debt began to decline in November, which was also the month the Nasdaq began to decline. Margin debt has since declined by 14.5%. The Nasdaq fell 17.6%.
And many of the high-flyers have collapsed by 60%, 70% and even more than 90%, some of which I follow in my collection of imploded stocks. Stock jockeys who were marginalized in these transactions turned into sellers forced to raise funds to pay off their margin debt. A marginal portfolio specializing in these stocks can be wiped out.
The increase in stock market leverage provides new fuel to the market. But decreasing leverage amounts removes that fuel.
The S&P 500 peaked on January 3, followed by a strong sell-off and has since fallen 8.8%. In January, margin debt fell $80 billion, or 8.8%, the dollar’s biggest drop ever and one of the biggest percentage drops ever.
The percentage drops that had been higher were:
- Covid crash (March 2020: -12.1%);
- euro debt crisis (August 2011: -10.4%);
- Financial crisis (May 2010: -9.1%, November 2008: -18.1%, October 2008: -19.7%, August 2007: -13.0%);
- Crash Dotcom (March 2001: -12.1%; December 2000: -11.6%; April 2000: -10.4%).
The stock market and margin debt are pretty much joined at their figurative hip. And declines in margin debt are associated with steep declines in the stock market.
Margin debt is not the only type of stock market leverage. There are other types such as title-based loans (SBL). Hedge funds can exert leverage at the institutional level. There is leverage associated with options and other equity-based derivatives, etc. Nobody knows how much leverage there is in the stock market.
Even the banks and brokers who finance this leverage don’t know the magnitude of the total leverage, or even the magnitude of the leverage that their own client has, which was the case when the family office Archegos, a private hedge fund, blew up a year ago and caused billions of dollars in damage to prime brokers who had provided the leverage. The amount of leverage used by Archegos did not emerge until it exploded and brokers had to sort through the debris.
But margin debt is an indicator of the direction of overall stock market leverage. Although total stock market leverage is far greater than margin debt, it is likely moving in the same direction and driven by the same dynamics as margin debt.
One thing we know: high leverage in the stock market is one of the prerequisites for a sell-off. In other words, a steady decline in the stock market can happen at any time. But it’s hard to have a sell-off without the massive leverage unwinding, the opposite of when that leverage fueled the rally with borrowed money.
Debt on margin and market “events”.
It is not the absolute dollar amounts that matter over decades because they are skewed by the effects of inflation. What matters are the sharp increases in margin debt before the fairsand the sharp declines during the fairs who followed.
But no rise in margin debt has been more jaw-dropping than the huge surge during the Fed’s $4.8 trillion money printing spree in 2020 and 2021, not in dollars or percentage terms, and this has now started to dissipate:
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