Leverage versus stock market “events”: Margin debt plunged in June

Few took seriously the warning that Margin Debt issued last year.

By Wolf Richter for WOLF STREET.

There is a tremendous amount of leverage, and most of it is hidden until it detonates something. The Fed encouraged leverage through interest rate suppression and QE, and people took that encouragement and piled on it. Some of this leverage is already exploding with dramatic results, like leverage in the crypto world. In the stock market, leverage takes many forms. But only margin debt is declared and known, it is the only visible part of stock market leverage – the tip of the iceberg. And it is closely associated with “stock market events”.

In June, margin debt plunged $69 billion from May, the second-biggest month-over-month fall on record, behind only January’s $80 billion plunge, Finra said. based on reports from its member brokers. As a percentage, margin debt plunged 9.2%. This type of percentage down is invariably associated with the biggest stock market sell-offs, as we’ll see in a moment.

At $683 billion in June, margin debt was down $252 billion, or 27.5%, from its October 2021 peak ($936 billion). The Nasdaq peaked in mid-November and has since sold nearly 30%. The S&P 500 peaked in early January and has since sold nearly 20%.

This chart is an indicator of the gigantic levels of risk being taken in 2020 and 2021 thanks to inflated leverage – margin debt being just the tip of the iceberg. From November, it became an indicator of market turbulence. And now it’s an indicator of a huge amount of leverage that has yet to be unwound.

“Events” in the financial markets and more than 9% drop in margin debt.

The month-over-month percentage declines that had been nearly as big or bigger than June’s 9.2% drop all happened during financial market events, going back in time:

  • Covid crashMarch 2020, debt margin: -12.1%
  • Euro debt crisisAugust 2011, debt margin: -10.4%
  • Financial crisis crashmargin debt decreases:
    • August 2007: -13.0%
    • October 2008: -19.7%
    • November 2008: -18.1%
    • May 2010: -9.1%
  • internet crashmargin debt decreases:
    • April 2000: -10.4%
    • December 2000: -11.6%
    • March 2001: -12.1%
  • October 1987 crash

The crash of October 1987... Just for fun. The data on margin debt that I have access to dates back to 1990, so it does not include margin debt levels on the eve of the spectacular October 1987 crash, when the S&P 500 crashed 32%. in 10 trading days, including the 20.5% plunge on October 19 (Black Monday). And there was a record amount of pre-sale margin debt and a record amount of margin calls and forced selling during the crash that accelerated the crash.

This is what leverage does: it drives prices up before, and it drives prices down during the sale. Leverage is the big throttle, both ways.

The numbers were tiny compared to the current Fed-sponsored leverage frenzy and after 35 years of inflation. Archives of Los Angeles Timeswhich is kinda cute today, I mean, ugly 44 billion…

“Margin debt at the end of September had reached a record $44.17 billion, double the $22.47 billion at the end of 1984 and four times the $10.95 billion five years ago, according to More than 2.8 million investors have margin accounts, with the average account size reaching more than $4,880, up from $1,415 in mid-1984, when the NYSE began tracking them .

The LA Times also reported in the same article some of the side effects of exploding leverage, and it’s not so funny anymore:

“On Monday [Black Monday], a distraught Miami investor – who reportedly faced a margin call – fatally shot the branch manager of his brokerage office and seriously injured his broker. The investor then committed suicide.

Spreading margin debt signals.

The surge in stock market leverage adds new fuel to the market. But the disappearance of leveraged quantities not only removes that fuel to pour into the market, but pours water on the fire, when investors get spooked and sell stocks to pay off their margin debt, and when margin calls are triggered and the forced sale kicks in.

Margin debt, when it explodes, can serve as an effective warning signal of the risks and problems that are building up in the stock market. And when it starts to decline, as it did last November, it can sound the alarm.

No one ever takes this alarm bell seriously, and it’s loudly ridiculed by hype-mongers who want to put margin debt charts on a logarithmic scale or adjust it for inflation or whatever , or both, to hide problems and cover risks.

If someone tells you to put a financial chart on a logarithmic scale, like margin debt, to make it less scary, run!

No one took the margin debt scare seriously at the end of last year. Well, maybe some people did… Microsoft CEO Satya Nadella sold 50% of his Microsoft stock on November 22, totaling $285 million, for an average price of $349.59. Monday, Microsoft [MSFT] closed at $254.25, down 27% from its average sale price. He had saved $80 million so far.

When a market is whipped to ridiculous levels, it’s worth getting out of. Hundreds of hype and hoopla stocks have now crashed 70%, 80% and over 90%, and I’ve tracked some of them in my Implosed Stocks column.

Margin debt annotated with market “events”.

As far as the warning sign of margin debt goes, the absolute dollar amounts over the decades don’t matter. What matters are the sharp increases in margin debt before the fairsand the sharp declines during the fairs. The chart below shows the relationship between margin debt and “events” in the S&P 500 index, including the current “event”.

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John A. Bogar