A report today from Portales Partners on brokerage margin debt, which at $318 billion is 14% above its highest level reached in March 2000 — the year the dot.com bubble burst.”
Cause for Concern?
Posted in * Culture-Watch, Personal Finance & Investing
what is the ration of margin debt to brokerage accounts – that is the real measure of risk.
YBIC,
Phil Snyder
I have taken to shorting lately. Seems to be working well.
But the economy is doing quite well.
DonGander
“what is the ration of margin debt to brokerage accounts?”
Probably something less than 14% higher than March 2000.
I wonder if that simple 14% higher than the last boom-bust is necessarily a best analysis of the current situation. It is an indicator but it makes a difference what earnings are like (or reasonably will be like in the future) in comparison. Also, what is invested in? The dot.coms were radically overpriced and most had no earnings but a few were fantastic successes (like E-Bay).
But it is wise to know how stretched the investors are.
DonGander
Most definitely cause for concern. It’s yet another symptom of boom mentality in which lenders, borrowers, and investors become complacent about financial risk:
— Banks and other lenders face competitive pressure to lower risk premiums (i.e., the higher interest rates risky borrowers must pay) and credit standards. Lenders are left with riskier portfolios and are not receiving interest rates proportionate to the risk.
— Business borrowers borrow extra money because interest rates are low and credit terms so favorable.
— Consumers spend more on consumption (“everybody’s doing it, right?”), save too little, and go deeper into debt.
— Institutional investors, under pressure to keep up with their high-flying counterparts, don their rose-tinted (“but the price/earnings ratio is really quite reasonable if you calculate it based on projected future earnings”).
— Invididual investors, abetted by herd mentality and commission-driven investment advisers, chase the last big thing (e.g., the sectors or mutual funds that did well over the past three years)—unwittingly setting themselves up to buy high, panic, and sell low.
Moral: There’s something in most of thus that wants to buy when the market is rising and run for safety when the market falls: buy high, sell low. Many of us would do well to save more, spend a bit less, be wary of going into debt, and avoid borrowing to pay for immediate consumption.
Most individual investors should NEVER buy stocks with borrowed money. In so doing, you set yourself up to be squeezed between rising interest rates and falling stock prices—and forced to sell at a needless loss.
Two postscripts to my comment #5:
— I don’t see stock-market bubble of dot.com proportions but I do believe investors (like lenders and borrowers) have become far too complacent about risk.
— Lest anyone think Irenaeus has wed Cassandra . . . . On questionnaires designed to ascertain how much risk an investor feels comfortable taking, I consistently score as a big risk-taker. Thus, for example, the Vanguard and Fidelity tests tell me that I (despite being of Baby Boomer age) should have 100% of my portfolio in stocks.
But now is not the time to take on more risk. If you want more risk, wait until the market falls and other people get their fingers burned.
You all are missing the mark. Just because a person ( institution ) has margin debt, do not assume they are all long. More likely, there is a correlation between the amount of money in hedge funds and margin debt. The average “Joe” is not margined at all. The daytraders do not amount to much money, they just churn $20,000 accounts.
Bob Lee [#7]: If you’re comfortable with current debt levels, credit quality, and investor risk-perception, let’s compare notes two years from now.
I don’t think you can buy hedge funds on margin.
There are lots of “average Joes” who are leveraging their returns with margin accounts. It’s when things go south and they can’t meet their margin calls that a small correction becomes a bloodbath.
Ruidh [#9]: You’re right that people don’t borrow to fund their investment in a hedge fund. But hedge funds themselves do use margin debt. I think Bob Lee is suggesting that the growth of margin debt correlates with, and is explained by, the growth of hedge funds. That may well be. But (for reasons that would require a more extended discussion) it’s still consistent with the broader picture of investors expecting long, sunny days to last indefinitely—the psychology of an advanced bull market.
Iranaeus, the article is about brokerage margin debt. Not that which you speak. My comment was on brokerage margin debt. I have personal extensive experience on this, and will compare notes with you on this anytime you wish. But then, I already did, in my comment.
bl
Not an issue, margin debt is exceeded by cash balances in brokerage accounts by a very very large amount