Margin Debt

[nodoodahs]

I covered margin debt in a couple of posts on the blog. I think it is a non-issue.

We don't know who racked up the margin debt. It could have been pattern day traders, who rack up huge margin usage but never commit to a directional play on the overall markets, retail customers who should be faded, or large institutional customers who shouldn't be faded. Without that data, you can't really use margin debt as a sentiment indicator for smart or dumb money.

Part of the margin debt is from short-selling, but we don't know what proportion of the debt is from selling or buying. Without the ability to construct a bull/bear margin debt analysis, the amount of margin debt is not useful as a sentiment indicator.

Interest rates are a lot lower now then they were in 2000, and any rigorous analysis of margin debt should take that into account. Any significant lowering of margin interest would be likely to stimulate traders to take on increased debt, so a couple of hundred basis points worth of lower rates might need to be “adjusted out” of the new peak number.

The dollar value of stocks traded is 40% higher today than in 2000. At the stock market peak, about 30 billion S&P 500 shares a month traded hands. Today, we are averaging about 45 billions S&P 500 shares a month. Even after accounting for (slightly) lower share prices, it would seem that an adjustment for margin debt per dollar value traded is in order.

Just the dollar value and margin interest adjustments would put us about 40% below peak levels on a back-of-the envelope calculation. Even then, without directional and constituent information it is a useless indicator.
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[rffrydr]

....Apple, Apple, Apple. And it's a cheap credit card. Otherwise Retail doesn't have anything much to do here anymore.
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Today is the Tomorrow you worried about Yesterday!

[HenryTo]

US margin debt outstanding increased by $4.3B to $335.2B during April. Hits highest level since July 2011. Recent correction/deleveraging still isn't over.

[HenryTo]

FYI

http://www.bloomberg.com/news/2011-08-15/margin-calls-push-stock-leverage-down-most-in-year-as-s-p-500-tumbles-12-.html

[rffrydr]

This is the first real test of the hard asset option players staying power. Just the headache of position management ought to be shaking out risk. Looking for positive monday.

The Close-Out Friday Blues

By Timothy Collins

[HenryTo]

All valid points but if one dates the start of the thread (2007), the rapid increase in margin debt in the 18 months leading up to July 2007 turned out to be a gigantic issue. Not so much because it was the cause of the liquidation in assets; but because it turned out to be (still) a somewhat reliable indicator of the leverage inherent in the system.

We don't have reliable data given the proliferation of derivatives, hidden leverage within banks' balance sheets, and even pension funds like CalPERS and endowments like Harvard. I would argue this is the best we have. One could make a similar case during the run-up margin debt to early 2000 as online options and futures trading were just becoming popular at the time.

I would not put this at the bottom of the list.

[rffrydr]

Yeah, as good as this indicator was back in "the day" it goes to the bottom of my list at this point.

As the start of this thread shows, the issue is complicated in the best of times, even in its weekly moves. '97-2000' were the go-go times for the day-traders and, other than the manic end, the best they were able to leverage up nearly matched the most extreme level of '09's mother of all margin calls lows. No doubt there are several stories for this but one take might go like this.

The "Greed born of Fear" nature of the housing boom, pushed money into yield. Because yield is safe, it can be leveraged. Margin was just the stock market's equivalent of a 3-5 ARM, a precipitated a structural change. Greenspan's cuts fed the loop. Huge shorting operations to strip out this yield from "risk" turbo-charged the whole thing.

Meanwhile, the individual investor, in the classic sense of buying stocks representing some "vision" of the future nearly vanished. Apple, Amazon are the exception that prove the rule. If they weren't in a REIT they just weren't interested. Buy RE, they aren't making any more of it. What are we left with? The core risk-takers. They are going to be margined up as befits their character. And dare I say with the global investor drifting in, there is no fluffery about what is or is not a casino.

Shorting is no longer a bugaboo. When options were first introduced in early 70's there were no puts. Public should not be able to "bet" against america. That's all gone now. And we have 3X ETFs to spice things up a bit. And dividend stripping hedgie is back in town.

Low, low...low rates.

We have witnessed a paradigm shift in this indicator. It needs to be respected--that is suspected. Cash is sitting in distressed RE, gold, offshore accounts and is only just these past weeks tip-toeing into the market in the form of hybrid funds--bonds with a hint of stocks.

Now it's a question of math and the other margin--profit.
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[rffrydr]

We never got down to go-go '99 highs in margin falloff this Great Recession. Portfolios couldn't be sold...but borrowed against???

Wouldn't we expect to see more margin considering where we came from and where we are going? It's still a ZIRP world out there.
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[rffrydr]

No, that's right. And Moodys would have to account for that margin contribution, calling it some kind of "enterprise value." I never thought of it like that--gotta remember to think outside the balance-sheet boxes. No ordinary accountant would have added it up like that.

But follow it: We now have built our "platform" on backs of our own shareholders, right? Each with twice the "ownership" than he can afford. [that ROE would have to be ROMyE] Genius!....until everybody (or just enough) does it and something goes out of kilter somewhere.

Banks make for a better fall-guy--they're not guys.

It is shrewd though, be "insulated" from your own shareholders. The plate stays spinning...for awhile.
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[HenryTo]

Come on rffrydr, the theory works VERY WELL on paper and when I do the math in my head.

Take care,

Henry

[rffrydr]

The leverage is "Transferred to the Shareholder." Let's get Moodys in on this!

Better to just say it: If we are living in an age of globalization, in the end, there is no such thing as a Platform Economy. It just depends on your time frame--and a 30year mortgage is a long time.

http://www.marketthoughts.com/forum/viewtopic.php?t=3133&highlight=platform
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[HenryTo]

From what I've been reading, a significant chunk (some sources say even most) of the increase in margin debt in recent months can be directly attributable to speculators buying ADRs, foreign ETFs, or foreign mutual funds. Like rffrydr said, we will never know but that hasn't prevented this indicator from working in the past.

In fact, this indicator has worked pretty well in the past, since actual margin debt is usually used as a "last resort" in order to leverage long into the stock market. That is, the sophisticated hedge funds and individuals and so forth will go long/short via futures - but it is the retail investor who leverages into the long side using margin debt. Immediately prior to the '87 crash, we didn't see any substantial climb in margin debt (the leverage was being reflected in the futures data, however), but whenever we've seen a substantial climb in margin debt, the market has always subsequently corrected.

That being said, I don't think the recent rise in margin debt is close to being "substantial" yet - as, like Bill mentioned, trading volume has increased substantially since early 2000. The lack of volatility is also worth a mention (thanks Dash) - as the increase in margin debt is just one of the many things that are playing out in this world of highly-leveraged hedge funds with highly leveraged strategies - due to record low yield spreads, etc. Moreover, cash levels at the biggest U.S. corporations are also very high. Debt levels are minimal - so I would not be too worried as this merely reflects a "transfer" of the leverage from the company to the shareholder. In fact, in theory, we should encourage such a transfer - as long as margin debt interest isn't overly high relative to the ROIC or ROE of the firms they are holding shares in.

In theory - once the prime rate moves above a level that is higher than the ROIC or ROE of the biggest foreign firms in emerging markets, then it is "game over." Note that I said "in theory."

Now, short interest on the NYSE remains approximately 2% of all outstanding shares - and so the best assumption would be to assume a consistent amount of short-selling via taking on margin debt on a month-to-month basis. I've seen no evidence to contradict this otherwise (or maybe I'm just not looking at the right places).

[dash]

The other important question to ask is whether the increase in margin debt is a rational or purely a speculative thing.

GavCal has talked a lot about the emergence of 'platform companies' like Dell and Apple which have outsourced the most volatile part of the production cycle (manufacturing) to Asia. As a result, weaker growth in the US no longer results in big layoffs and inventory cuts, but in a decline in imports and a loss in output/jobs/inventories in the developing countries which have taken on the manufacturing process. This in turn has led to a drop in the volatility of the US business cycle: unemployment, GDP, inflation are all much less volatile now than they were 20-years ago. The low VIX is not particularly surprising in light of this, though don't tell the bears who true to form have been suggesting it's a sign of an impending meltdown.

But getting back to the issue of margin debt, if our economy is now less volatile, people are going to feel more secure about their jobs and, as Franco Modigliani has pointed out, it makes sense for them to take on more leverage.

[rffrydr]

Thanks, I was just thinking it's time to take a look at this. And, like the short-interest must be seriously qualified.

* I don't know that it's worthless, we haven't been able to discriminate before and yet it was useful.

* Our little interlude with NFI has proved that there are exciting new (hedge fund) ways of trading a stock without leaving the traditional tracks. Huge margin debt was generated in boosting the puts to sell and collect the implicit dividend......

* As an extension of the debt-laden culture in which we live however the burden is to prove its unworthiness. Otherwise you gotta give it the benifit of the doubt.

* Alot of the dot.com day traders have moved to futures.

* Don't institutional companies get "financed."?

* Margin rates are based on short rates, broker's "prime." Not much diff. here from '99.

* No doubt, the ever-rising dollar basis does need to be accounted for--as with the short interest.

* The Schwab surveys should be a help here.

* Let's ask Master Henry, I bet he knows
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