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The Margin Debt Time-Bomb
Submitted by Brian Pretti via PeakProsperity.com,
What is perhaps the greatest risk to individual investors these days?
Is it the potential for a decline in corporate earnings based on a slowing global economy? Is it that current valuation levels in both equities and fixed income instruments are much nearer historic highs than not? Is the biggest risk a US Fed that will soon raise interest rates for the first time in close to a decade?
Although all of these are specific investment risks we face in the current cycle, my contention is that the single largest risk to investors is a risk that has been present since the beginning of what we have come to know as modern financial markets. The single largest risk to investors is themselves. By that, I mean the influence of human emotion and psychology in decision making.
We Are Our Own Worst Enemies
After many years of managing through market cycles, it seems pretty clear to me that humans are uniquely wired incorrectly for long-term investment success. When asset prices double, we want those assets twice as bad. When asset prices drop in half, we want nothing to do with them. Isn’t this exactly what we saw in US residential real estate markets a decade ago? Isn’t this what we experienced with the rise in dot-com stocks in 1999 and their demise over the three following years? Human decision making shapes the rhythmic bull and bear market character of asset prices. We know the two most prominent emotions that drive markets higher and lower are those of fear and greed.
If we turn the clock back far enough in early human history, we know that humans ran in packs. Strength and protection was found in a pack or herd. It was when humans ventured away from the protection of the herd (consensus thinking) that they were physically vulnerable. The fight or flight mechanism has been an integral part of human development over time. Several thousands of years later, these learned decision making responses are simply hard to “turn off.” We find comfort in decision making within the herd. When confronted with challenge, it’s either fight or flight. These ingrained human character traits are why we often see investors buy much nearer a top and sell close to market bottoms. Decision making driven by emotion, as opposed to logic, is the single greatest impediment to long term investment success. There is an old saying in the markets: “Human decision making never changes, only the wallets do.”
Human Emotions Meet Animal Spirits
Just what does this have to do with decision making in the current environment? Remember, as investors, controlling our emotions is probably the single greatest obstacle to sound decision making. As such, we need to anticipate potential emotional triggers so we can better confront and allay our own human responses to market outcomes. There is probably no greater human emotional trigger than actual price volatility itself. If we can anticipate and understand why price volatility may occur, we hope to dampen our own emotions and objectively steer through the vagaries of market cycles.
What we are seeing in the current market environment as a catalyst for potential heightened forward market price volatility is the current level of NYSE margin debt outstanding. You may be familiar with the financial market characterization of “animal spirits.” The concept of “animal spirits” is integrally intertwined with human emotion, in this case meaningfully heightened confidence. There probably is no greater show of human confidence in the investment markets than borrowing to fund an investment. Certainly, leveraged investors expect a return above their cost of capital, with expectations usually much higher than just this simple metric. The direction and level of margin debt outstanding at any time is a reflection of these so called “animal spirits,” it is a reflection of human confidence.
The Margin Debt Time-Bomb
Let’s have a look at where we now stand. As of July month end, NYSE margin debt outstanding stood just below a record level of $500 billion. It hit a new all-time high right alongside the equity market itself, exactly in line with what we would expect in terms of the emotional side of human decision making.
A few observations regarding the consistent patterns of human decision making seen in the historical rhythm of margin debt are important. First, it is clear that margin debt peaks very close to the final run to cycle highs in stocks with each bull market cycle. Remember, when asset prices double, we as humans want them more than ever, but when prices are cut in half, we avoid them like the plague. At the recent peak, margin debt was up just shy of $50 billion this year after being flat in all of last year. After these near vertical historical accelerations at cycle tops, margin debt has peaked and begun to decline while stocks temporarily go on to new highs – this divergence being the tell-tale indicator equities have peaked for the cycle. Because this data comes to us with a bit of a short-term lag, it’s seen in hindsight. At July month end, the S&P traded above 2100, while margin debt balances fell just shy of $18 billion. On a very short-term basis, this divergence was established in July.
Where we go ahead will now be important. Official NYSE August margin debt levels will not be available for a number of weeks, but it’s a very good bet margin debt levels contracted again in August, perhaps noticeably. As I watched the Dow open down over 1000 points a number of Monday’s back, it was clear margin liquidation drove the open. Price insensitive selling dominated early trading in many an asset price gap down.
As we step back and reflect on “rational” decision-making, it would be much more appropriate (and profitable) if margin debt outstanding peaked near the bottom of each market cycle (low prices) and shrank near the top. As long as human decision makers susceptible to emotion are involved, that is not to be.
The final important observation germane to our current circumstances is that when market prices turn down, margin debt levels drop like a rock. Think about leverage. It works so well when the price of assets purchased using leverage rise. Yet leveraged equity can be eaten alive in a declining price environment. Forced liquidations are simply price insensitive selling. Of course, this will only occur after prices have already dropped meaningfully enough to either force margin calls, or cause margined investors to liquidate simply in order to remain solvent or limit loss. We have certainly seen a bit of this in recent weeks.
Why is all of this talk about margin debt important?
In Part 2: The Criticality Of Monitoring Margin Debt Closely From Here we explore how ever higher levels of margin debt represent tomorrow’s heightened price volatility in some type of a stressed market environment, whether that be a meaningful correction or outright bear market.
Both are an eventuality, the only question is When?
Click here to read Part 2 of this report (free executive summary, enrollment required for full access)
»
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Lever up bitchez!
What have you got to lose? ;-)
nmewn, that is what the pit boss says at a casino.
When the odds are in the houses favor or it's a rigged game, why not loan money to the suckers at the table.
Casino markers can be issued to just about anyone who requests one. It is a zero-interest line of credit that is intended to make gambling easy and accessible to everyone. A gambler fills out an application for the line of credit, and pursuant to NRS 205.130, a gambler is given 30 days to pay back the debt.
"nmewn, that is what the pit boss says at a casino."
Exactly my friend, its all in how one interprets the question being posed.
"What have you got to lose? ;-)"
Might have to "cable up" (been two years) because bitchez 'bout to lose IT ALL and watching the cheerleaders on CNBS attempt to walk it back will be priceless.
Take out a loan for teh we! Load up with teh shiney! Bankrupt banksters don't have any g0ld coin to pay teh repo man!
Drop the "D" on DEBT and you've got EBT... hmmm, as in EBT Cards... Funny how things work...
What the fuck is "teh we" supposed to mean? Are you illiterate?
That is *fonestar* you idiot.
CREDIT==invented by Banksters to enslave the weak
Fuck you Brian.
This article is more bullshit marketing to sell more bullshit.
The fucking fear of raising interest rates is an acknowledgment that the Fed has supported a phoney recovery that no one believed in anyway.
The taper tantrum was the first wheel removed. The interest rate rise will be the second wheel removed. Ending the Fed will be the last wheel removed.
Love, Alexa
agreed Alexa.
Tyler(s) can't we please stop this kind of useless pandering pedaling by people trying to fake some real knowledge of economics and markets to make a buck?
agreed Alexa.
Tyler(s) can't we please stop this kind of useless pandering pedaling by people trying to fake some real knowledge of economics and markets to make a buck?
It's not pretty Pretti.
You will have more cred by discovering why you double post?
Copium, it's a helluva drug.
If the economy cant handle a .25 rate hike then it probable all deserves to come crashing down
"This article is more bullshit marketing to sell more bullshit.".
Amen. Everyone has to make a living, but ever since Chris Martenson left his high paying Wall Street job to become essentially a wealthy "prepper", he seems to have become not much more than a used car salesman. Advertising his website and publications aren't enough for him, it's always "pay me, pay me...".
Okay, time-bomb. So the margin debt collapses first, dragging the market with it? This is my first time paying attention and I want to get the dominoes in the right order.
Yes, but the Margin debt on bigger playas is called derivatives, and $500 bil looks like pocket change.
"At July month end, the S&P traded above 2100, while margin debt balances fell just shy of $18 billion."
How much debt is on the books of corporations that was used for share buybacks?
Is the Fed's balance sheet considered off balance sheet commercial banking system debt that is merely being rolled at the Fed's discretion?
How much leverage is in the Interbank Repo Market?
How much leverage is in the Derivatives Market?
Yeah, yeah, yeah, I know. Ok: net it out and tell me how much.
+1000 Throxx. Hell, I bet Jamie & JPM have AT LEAST $ 500 billion in margin debt.
A little 20 to 1 leverage in the quadrilion dollar derivative markets never hurt anyone? What could go wrong?
Exactly.... Net, Net, Net....
Bankers and banking families are the world's worst enemies. (Fixed it for you)
Look at expectations (false), look at points of control (corruption), look at values (shallow)...
therein you will find trajectory...
So then,
the trajectory will change only when false expectations are reworked, corruption is resolved, and values are righted towards at least a sustainable and civil society...
All at once.
My pantry is stocked with popcorn, bourbon and cigars. The greatest show on earth is about to begin. P.T. Barnum. Eat your heart out.
i think bill clinton's ears just perked up (cigars & that avatar)
Another troubled youth that needs mentoring?
Saint Luis Rey Reverva Especial
Always a perfect smoke.
The Bellicoso shape requires an experienced roller.
You cannot go wrong.
Pay attention.
This is a good article.
Short and sweet... Just like the fuse on a stick of (debt dynamite)~
Tick...tick...tick...
Where do you get this "WE" shit Kemosabe? Just stack and walk away.
https://app.box.com/s/6lmrowbj1ajnu4kkijoorymapzx08a4o
https://app.box.com/s/9lpnetsoshy1qg58vdneiq4m0ar5ywwi
https://app.box.com/s/i09uu2guzt8s77abz68dx1xn872h18et
Margin calls coming to a brokerage near you.
Before we have to sell AAPL, "dis-ease" care, social mania, and biobubbletechs, MOAR QEternity n+1 . . . , please!!!
The TBTE banks' offshore shadow banking's pass-through entities using exchange-sponsored HFT are levered 50-80:1 banking system capital (what's that?) at ZIRP AND via "unitaleral" (uni-party) netting vs. 25-30:1 bilateral netting in 2006-08.
We're facing the end of the (financial) world that we don't know (it).
The preppers with their guns, grub, and gold are not such nutters after all. Well, they are but for a good reason. :-D
Don't worry. We are sending Obama back up to Alaska for new selfie photo. It won't be hard to find a turd in white snow.
Railroad Crew Uses CANNON to Create an ...
Quote from a Wall St. banker in Mar 2008: "It's all funny money. Who gives a $h!t if it blows up. The little people always pay. F$&k 'em."
He subsequently lost $110M of not-so-funny money, his $5M house, his silicone-breasted, bottle-blond trophy wife, and a bullet from a 45 in his cranium.
Morale: Don't have a $5M house and an impatient, silicone-breasted, bottle-blond wife. ???
If the next crash is as bad or worse than 2008-09, as is likely, lots of errant bullets will be flying in all directions.
Duck and cover.
Not that I don't believe it.. Mr 3 weeks......
http://www.zerohedge.com/users/newnormaleconomics
It's so common as to be unnewsworthy.
Yes, new is the new old . . . and unnewsworthy.
Much obliged. Be seeing you . . .
The Federal Reserve's plan of infinite debt and QE will have consequences.
Yes, infinite debt and more QE.
Are we really that concerned that those that have money are leveraging it to make more? After all, 55% of Americans aren't even in the stock market. In other words, if you polled the "man in the street" more than 50% of those polled could care less about whether the market went up, down, or sideways the last couple of weeks or the last six years.
Among them are the least weathly and the youngest. In other words, Americans that need a return on their money the most - the poor and the young missed out on the S&P 500 tripling since 2009.
For those that did - Americans that were already weathy and older - they, according to this report - not only took advantage of a rising market they leveraged this rise and made even more money.
And, it is these people that are and will be the ones to ride the market down. That is betting money that the market will fall - with leverage (hint: it works both ways - you can leverage your investments going down as well). Wow! That kind of blows up the authors argument - sorry . . .
Yup margin debt nicely cyclical in spite - or because of - the Fed. Easy to visualize and track on Doug Shorts awesome chart:
http://www.advisorperspectives.com/dshort/updates/NYSE-Margin-Debt-and-t...
The other two biggies are Initial Claims ("off the lows") :
http://www.advisorperspectives.com/dshort/updates/Unemployment-Claims-an...
and finally the Buffet indicator:
http://www.advisorperspectives.com/dshort/updates/Market-Cap-to-GDP.php
Look at these charts, and then the economists who have claimed that the "business cycle is obsolete". Then trust the graphs, don't trust economists, and plan for the next recession. It promises to be a worldwide doozy. And a parting comment is that the unemployment rate that the Fed obsesses about is really phony. ZH'ers know that all the new jobs are bartender and waitress jobs and also it is commented that if the people "leaving the workforce" since the GFC were counted, then the unemp rate would be north of 9%. So the current "Fed watched" rate is really bogus.
Good luck.
Bernanke thinks margin debt caused the '29 crash.
He's wrong. Stupid people with margin debt caused it.
Just like "the gun" killed whomever, rathe than the person pulling the trigger.
First the interest rate hike and then QE4,5 and 6 to the rescue.The Fed checked into The Roach Motel and Cockroaches are standing outside the door with baseball bats.