FLASH UPDATE: Borrowing has hit all-time record levels

Borrowing has hit all-time record levels

Are investors reaching too far?  Leverage is back, in a big way...  We can observe similar surges in leverage in late 1999 / early 2000 and late 2006 / mid 2007.  The latest data puts margin debt, a leverage indicator defined as the aggregate dollar value of securities purchased on margin, at record highs (in nominal and inflation-adjusted dollars).  “You can’t use this for timing, but you can use it to be prepared for trouble,” said Ricardo Ronco, head of technical analysis at Aviate Global.  The language written to describe these two past periods is eerily similar to what is being written today. 

• ie. “The National Association of Securities Dealers (NASD) has asked members to review their lending requirements in a sign of increasing concern that rising levels of margin debt could exacerbate a stock market plunge.”
• “High margin debts show the effect of over-leveraging and mispricing of risk”.
• “Either the market rises dramatically to make those loans good or in any down move there is tremendous selling pressure”.

We are not predicting a crash by any means.  We are merely pointing out a factor that could exacerbate selling pressure once it starts.  We think corporate high yield defaults will increase year-over-year and at some point over the next 3-5 years, they may be significant.  JP Morgan recently said that the concern was overblown, but stopped short of waiving the “All-Clear” sign.  The NYSE reports a metric called net debit, which is monthly total debt levels in brokerage accounts minus cash and credit.  A large positive number indicates high borrowing.  January’s reading was approaching the record high seen in February 2000.  We are at all-time leverage levels, only bested once in February 2000!

Margin debt, which rose to an all-time high in January of $451 B, is a sign to some of overheated speculation.  What if that overheated speculation over the last few years has made outsiders feel like they missed the post-crisis bounce in equity.  We are in rare territory currently, being in a 5 year+ bull market.  Of twelve bull markets since WWII, only three have made it to a sixth year.  If they felt that way, did they just invest in some “safe” high yield mutual fund or ETF.  All-time low yields and spreads in HY might indicate that this is the case.  We urge caution in the high yield space, as we continue to find additional cracks every day.

We wish everyone a happy holiday,

Richard Travia

Director of Research