HowWealthWorks.com

[Suresh]

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This is from the Chart of the Month commentary at Alan M. Newman's Stock Market Crosscurrents.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Dave]

Around the time interest rates were bottoming, and prime rate was bottoming, margin borrowing was starting to wake up.



The question I have is this: will high interest rates be a further headwind to the stock market? With the small cap rally running out of steam, will investors continue to pile more and more debt into the stock market?

Stay tuned until next week, when we find out where the market is headed!
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Dave

Please feel free to agree with or critique the article excerpts and our comments. Alan Greenspan: Gold and Economic Freedom

[Suresh]

Margin Debt Up 22%
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Our prior looks at Margin Debt saw a rise, but not to levels that reflected excessive levels (see NYSE Member Firms’ Client Margin and NASD Firm Margin Levels Spikes to Record Levels).

Because it is so much larger than NASD issued margin, NYSE member clients borrowing matters more. While rising, NYSE Margin has not yet hit the levels that raise red flags. However, it is getting increasingly close:

[Suresh]

NYSE Margin Debt Reaches $285.6 Billion, Topping 2000 Record

The amount of money borrowed from brokerages that do business on the New York Stock Exchange to buy stock reached a record $285.6 billion last month, topping the prior high set at the peak of the so-called Internet bubble.

Changes in the level of margin debt, as the borrowing is called, have mirrored those of U.S. stock indexes. After setting an all-time high of $278.5 billion in March 2000, margin debt dropped to less than half that amount by September 2002.

The Standard & Poor's 500 Index and Dow Jones Industrial Average set records in January and March of 2000, respectively. They reached their nadirs on Oct. 9, 2002, by declining 49 percent and 38 percent. The subsequent bull market has put the S&P 500 4.6 percent away from a record, and the Dow at an all- time high.
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So, . . . leverage as a percent of market capitalization is even more extreme than in the heady final days of the last stock market mania?

I couldn't find an up-to-date, but the following chart gives you a sense of the near vertical rise in margin debt since 2002.



It's easy to dismiss the magnitude of NYSE margin debt by saying that it is still just over 1% of the total market capitalization of the NYSE(, which is around $25 trillion). Frankly, I don't have a quick retort. But, I do wonder whether the Pareto Principle applies to stock market gains and losses, wherein "the vital few" (20%) influence effects more than the "trivial many" (80%) to use the words of Italian economist Vilfredo Pareto. (Yes, yes, I know Signor Pareto used his concept to describe inequalities of wealth distribution and not asset markets). As Wikipedia notes, [i]f the parameters in the Pareto distribution are suitably chosen, then one would have not only 80% of effects coming from 20% of causes, but also 80% of that top 80% of effects coming from 20% of that top 20% of causes, and so on (80% of 80% is 64%; 20% of 20% is 4%, so this implies a "64-4 law"). By extension, 51% (80% of 64%) of the stock market effects may come from 1% (20% of 4%) of the stock market causes. Such stock market causes may very well include those traders who use margin accounts to apply what they believe is specialized and/or uncommon knowledge.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

NYSE Margin Hits All Time Record
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Bloomberg News has the details:

The amount of money borrowed from brokerages that do business on the New York Stock Exchange to buy stock rose 3.6 percent to a second straight monthly record, reaching $295.9 billion in February. Margin debt, as the borrowing is called, in January broke the prior high set at the peak of the so-called Internet bubble.

Changes in the level of margin debt have mirrored those of U.S. stock indexes. After setting an all-time high of $278.5 billion in March 2000, margin debt dropped to less than half that amount by September 2002. It reached $285.6 billion in January.

UPDATE: March 19, 2007 5:05pm

As I read the NYSE rules on this, I do not believe Shorts are included in this;

"Include only free credit balances in cash and margin accounts. Balances in short accounts and in Special Miscellaneous Accounts are not to be considered as free credit balances."

-Rule 421. Periodic Reports
http://rules.nyse.com/NYSE/Help/Map/rules-sys427.html
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Record level of margin debt prompts regulator warning
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[T]he National Association of Securities Dealers ...,[t]he brokerage regulator[,] said yesterday the amount of debt investors took on to buy securities, known as buying "on margin," had soared to a record $321.2-billion (U.S.) in February. That topped the previous record of $299.9-billion in March, 2000, at the peak of the last bull market in stocks. Margin debt has more than doubled from $141.3-billion in January, 2003, the NASD said, three months after the bottom of a bear market in stocks.
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Under the minimum requirements, before trading on margin, ordinary investors must deposit at least $2,000 or 100 per cent of the purchase price, whichever is less.

Fed rules generally let investors borrow up to 50 per cent of the purchase price of securities that can be bought on margin. NYSE and NASD rules then require equity in an account to be at least 25 per cent of the securities' market value in that account, known as a "maintenance margin."
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The last time we visited this topic, I wondered how much the absolute margin debt amount mattered when it was such a small percentage of total market capitalization. Back on 14 March 2007, Russ Winter of wallstreetexaminer.com addressed the same issue.

[Suresh]

More investors take risk of buying stocks with loans
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The NASD, a brokerage regulator, recently sent out an "alert" to investors outlining the risks associated with margin. Through the end of March, the latest data available, the amount of debt taken on by investors to buy stocks totaled $317.7 billion. And while that was a bit below the $321.2 billion record hit in February, it still surpasses the $300 billion in March 2000 at the top of the tech-stock bubble.
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Here's a simple example of how buying on margin works: You want to purchase $10,000 worth of Google shares. In general, under Federal Reserve rules, you can borrow up to 50% of the total purchase price. You fork over $5,000 of your own cash and borrow $5,000 from your broker.

Why do it? If stocks rise, borrowing can boost returns. Assume Google shares rise 20%, boosting the value of your $10,000 investment to $12,000. Since you used borrowed money to finance half of your purchase, your percentage return is actually 40%, since the $2,000 gain was garnered using only $5,000 of your own money.
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But leverage cuts both ways, and can amplify losses as well as gains. ...
Say that initial $10,000 investment in Google falls 20% to $8,000. Your net loss doubles to 40%, since your initial cash investment of $5,000 has been reduced to $3,000

Investors may also be subject to the dreaded margin call.

The reason: If the price of the stock you bought with borrowed money loses value and your margin account balance drops below a certain level, it could prompt a margin call from your broker.

The stocks in your brokerage account are collateral for the loan, so your broker will contact you and ask you to deposit more money into your account to meet minimum balance requirements. If you can't come up with the cash, the broker has the right to sell stocks or other securities in your account without your knowledge or consent.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

NYSE margin debt rises to record $378.2 bln in June

Debt taken out to buy stocks on the New York Stock Exchange rose to a record $378.2 billion in June, according to NYSE data released on Monday.

Margin debt rose 7.1 percent from $353 billion in May, a previous record. So far this year, margin debt has increased 37 percent from $275.4 billion at the end of 2006.
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Under a pilot program called portfolio margining that began in April, several brokerage firms are now offering risk-based margin rules to institutional investors.

Portfolio margining allows a broker to assess a portfolio as a whole, which means an investor no longer has to put up separate collateral for their stock and their options holdings.

That makes a margin call -- a request for more collateral -- less likely and enables the investor to borrow more.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Increase in margin calls helps fuel sell-off on Wall Street
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When a stock dips below a certain point, brokers who lent investors money through margin agreements demand that the investors sell part of the stock or pony up cash to cover losses.

When that happens, investors often have to liquidate other assets, which can magnify stock market drops. It's also partly why the selloff in equities is hurting other markets, like metals and energy.
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Margin debt on the New York Stock Exchange was at a record $378 billion as of June, up 36 percent from the previous peak in 2000 of $278 billion, according to Schaeffer's data. Margin debt on the Nasdaq Stock Market is also at a record $30 billion, up 33 percent from the 2000 level of $20 billion.

The NYSE's level of margin debt has surged 37 percent just this year -- the biggest six-month increase since April 2000. This means about 1.94 percent of the money traded on the NYSE is borrowed money. Percentage-wise, however, there was more margin debt in February 2000, when a record 2.4 percent of the NYSE's total market capitalization was margin debt.

With less than 2 percent of the NYSE's $19.5 trillion market cap in margin agreements, it may not seem like margin calls could cripple the market. But Johnson noted that the numbers don't account for hedge funds that borrow money from banks and aren't NYSE member firms.

Furthermore, there's margin debt in other markets, like bonds, and other factors at play.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Margin Debt -- and Risk -- Is Growing

EVEN AFTER A RECENT DROP, margin debt remains within spitting distance of the all-time high it hit in July, and 43% higher than it was a year ago.
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Margin debt is essentially the loans that banks and brokerages make to investors, using their stock and bond holdings as collateral. Brokers will lend up to 50% of the market value of a security. By borrowing, an investor is able to ramp up his bet on a favorite stock or bond; however, it also raises his risks. If the value of the stock drops, the broker can ask the investor to put up more collateral or cash to back the loan or call the loan.

Based on historical levels, margin debt makes the market look risky and subject to a sharp downtick right now. It comes to 2.4% of total adjusted-market capitalization -- 3.4 times its 62-year norm of 0.74%. "These are certainly not the kind of numbers you see at the beginning of a bull market," says Ed Clissold, an analyst for Ned Davis Research in Venice, Fla.

MARGIN DEBT ROSE FROM $32 billion in 1990 to $278 billion (2.9% of market cap) at the height of the dot-com boom in 2000, then fell to $134 billion by 2002. But it's been climbing steadily since, eclipsing $300 billion in April.

The frothiness became very evident in the summer. In July, margin debt hit an all-time high of $381 billion. But as worries about subprime-mortgage loans set off a credit crunch in August, more than $50 billion of the debt got erased. Almost half of the margin drawdown came from brokerages such as Merrill Lynch, which called loans backing two Bear Stearns hedge funds.

What's particularly worrying to some is that margin debt is just one tool available to investors seeking leverage these days. Options and futures make it easier than ever to obtain leverage. So the near-record margin numbers may understate the situation.


Flashing a Warning: Margin lending, as a percentage of stock-market capitalization, is nearing levels last seen in the midst of the Internet bubble.
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September's margin numbers should be out shortly. Steve Levine, a former NYSE margin regulator who now consults, expects a $30 billion drop. "Brokers," he notes, have been "reducing leverage through additional margin calls." ...
[emphasis added]
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

The Market Oracle: NY Stock Exchange Contracting Margin Debt Levels Sending Bearish Message
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When margin debt is expanding, investors are confident and expose themselves to more risk in expectation of a rising stock market.

When margin debt is contracting, investors reduce the amount of margin they use because they are less confident about future up moves in the market. Lower margin debt levels have a corresponding drop in the amount of liquidity for the markets. Retracting liquidity is always evident in stock market drops.

The Margin Debt levels on the NYSE from 2000 to September 2007 are below. Note how they started to fall at the end of 2000. Then, they were in a continuous downtrend in 2001 as we experienced the beginning of a bad bear market. It wasn't until early 2003 that Margin Debt began to rise again ... and along with rise, the stock market started its next bull phase.

That takes us to what is currently happening. In August and September, Margin Debt on the NYSE had their two largest drops since 2003. Clearly, there is now less margin in use, and that is buying fewer stocks shares. Unless margin debt levels increase fairly soon, the market will face a tough 2008 for those trying to play the long side of the market, and it would be a good market for those who go Short.


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Two data points don't make a trend. But, margin debt levels now bear watching.
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

FT Alphaville blog: View of the Day: What we can learn from margin debt

One essential indicator for the future performance of US equity indices is the aggregate margin debt used by member firms of the New York Stock Exchange, Ashraf Laidi, chief foreign exchange strategist at CMC Markets US, tells the FT’s View of the Day column on Tuesday.

He says rapid declines in margin debt correctly predicted the prolonged bear markets in equities in autumn 1987, autumn 1998 and spring 2000.

Such declines in debt result from the execution of margin calls as client losses escalate to unsustainable levels, which is the case during mounting market volatility.

Mr Laidi says that after reaching a record high of $381bn in July last year, member firms’ margin use declined for the following four months, reaching a low of $322bn in December.

“This suggests that continued losses are due in the market, which is consistent with our expectations for a prolonged bear market in equities,” he says.

“The 12-15 per cent declines in stocks we predicted back in December are already under way.

“We expect another 15-25 per cent of declines to come by end of the first half as the macroeconomic deterioration coupled with prolonged losses in US banks and profit warnings will overwhelm the easing measures of the Fed....
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Suresh

Please feel free to agree with or critique the article excerpts and our comments. Also, please post excerpts from current articles that you've read and which may help all of us get a more complete macroeconomic big picture.

[Suresh]

Compare the December margin debt level of $231 billion with the levels in 2000.


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Zero Hedge: Margin Debt Increases By 30% In 2009, Currently At $231 Billion

The NYSE's most recent disclosure of margin debt indicates a surge in trading in margin accounts, where total debt shot up to $231 billion as of December, up $58 billion from February or 30%, and also an increase of 4.5% from November. This is an indication that "animal spirits" have surged by about the same amount as the broader market since the market lows: in other words, speculation is now rampant, and, to make things even better, is very much on margin, or leveraged. And we all know what happens when levered speculative bets turn out not quite as expected. For those who may be confused, Dow Jones provides a useful primer of how a margin call feedback loop tend to make things ugly, fast.