ETF Trends
ETF Trends

You know those annoying notifications that chime on your cell phone in the middle of the work day? The ones that sound off to let you know when Kim Kardashian’s daughter sits on a commode? Or when Donald Trump insults a member of the media? I get far too many of those. I’ve tried playing with the notification settings on the apps on my iPhone, but somehow, I still get a ton of unwanted messages.

Last week, I received a Yahoo Finance notification shortly after the stock market closed shop. The one-liner? “Stocks soar on judgment that Fed will delay rate hike.”

Let that sink in for a moment. Stocks are not rocketing because investors are confident about corporate profitability or sales. They’re not climbing due to jobs optimism or economic acceleration. The Dow moved higher for seven consecutive trading sessions (through Monday 10/12) because – in spite of seven years of 0% overnight lending rates – the U.S. economy is still too weak for a token tightening gesture.

No doubt about it. This is not the 80s or the 90s anymore.

Years ago, money managers, institutional traders and the overall investment community owned stock assets because public corporations were likely to grow their businesses in a strong U.S. expansion. Now? Investors own equities because the “no-go” economy still requires unimaginably cheap credit.

So what’s the big deal about leaving interest rates so low for so long? One reason is excess speculation. For example, plenty of folks own Netflix (NFLX) and they have enjoyed a number of years of extraordinary price gains. More recently, however, folks have leveraged account values in order to own even more shares of NFLX. Just as homeowners in 2005 used cash-out refinancing to acquire additional properties with negligible down payments, NFLX shareholders have used rising account values in margin accounts to buy more NFLX stock. As shares of the media giant rise – as NFLX begins looking like a no-lose proposition – speculators employ more leverage to acquire even more shares of NFLX. And why the heck wouldn’t you borrow to buy more? The Fed’s going to make sure that stocks won’t fall, right?

Borrowing money for the purpose of leveraging a stock position is known as margin debt. It has been a profitable venture for anyone who arrived early at the reflated asset price party.

Of course, parties eventually end. Those who overstay their welcome or who arrive late will will find themselves nursing monstrous losses.

Consider the fact that NYSE margin debt cracked at an all-time high near the $500 billion mark in April. By September, margin debt sank 6.7%, down to $473 billion. Why might this matter? There have only been four times since the turn of the century when margin debt pulled back by 6.7% or more – April 2000, August 2007, May 2010 and August 2011. Those are some relatively inauspicious dates.

Granted, 2010 turned out to be a short-lived correction in the early stages of the current bull market. The other three occasions – the dot-come tech wreck, the worldwide financial collapse and the euro-zone crisis – resulted in massive drawdowns for world stock benchmarks.

 

Margin debt deterioration is, of course, deleveraging within the stock market. Not only does it signal a lack of confidence that the borrowing-to-buy game can continue indefinitely, but significant declines in markets themselves trigger margin calls that, ultimately, force the sale of the underlying assets.

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