Margin Debt

1. Forced sales are the driving force of crashes. 
2. Forced  sales are caused by closing out leveraged (margined) positions. 
3. The more leveraged a market, the more prone it is to crash.

So let’s look at margin debt in equities.

As of last December (latest data available) FINRA reported total margin debt in customer accounts reached another record of almost $800 billion.(Chart 1). It is likely higher today.

 

Chart 1

How fast is margin debt growing versus share prices? Is debt growing faster, i.e. is the market becoming more leveraged? The answer is yes - since 1997 real, inflation adjusted, margin debt has grown by 360% vs. 190% for real S&P 500 (Chart 2). We can also observe from the chart that when margin growth goes “vertical” a serious market correction follows. Note that margin data is reported with a 1+ month delay.

Chart 2

 

Looking at 2020 alone, margin debt jumped 42% whereas the Wilshire 5000 index climbed 25%, meaning that margin debt rose 70% faster than the value of stocks used as collateral.

How margined are customer accounts? There may be a lot of margin debt, but are there also large credit balances? The answer is in Chart 3. As of last December, customer accounts had a net debit balance of $326 billion, just about the largest ever.. This includes all accounts, margined and not (also known as “cash” accounts).

Chart 3

Looking at Chart 3 for longer term "buy" and "sell" signals, it's clear that net credit balances (green on the chart) are a pretty good "buys", while large debits (red) are usually "sells" (but not always, since the higher value of shares must also be taken into account).

Now, margin debt reported by FINRA is not the only source of margin leverage out there, of course.  Indeed,  this figure reflects mostly retail customer accounts plus some smaller institutions who do not have access to "prime broker" loans.  Large hedge funds certainly do not borrow the same way or with the same terms as Joe Plunger. Therefore, FINRA margin data can be interpreted as a measure of retail customers’ appetite for risk and speculation. Right now, the numbers point to increased speculative risk.

 Add episodes like GameStop etc and obscure cryptocurrencies  going through the roof, and the conclusion is clear: individual speculators are heavily into this market, dreaming of fast riches.  This is ALWAYS the last domino to fall, and the only question remaining is how much damage will they do to themselves, the market and the economy as a whole.

Treasury, Fed, SEC... wake up!!!