High levels of margin debt on the New York Stock Exchange are raising concerns about the state of the rally.
Stephen Suttmeier, technical research analyst at Bank of America BAC Merrill Lynch, notes leverage, as measured by NYSE margin debt, rose 28% in March from a year ago to $380 billion. That figure is slightly below the July 2007 peak of $381 billion.
Market analysts track margin-debt activity as an indication of investors’ appetite for taking on speculative trading. It has been trending higher since bottoming out during the financial crisis and currently is hovering around all-time highs.
“Leverage can be used as a sentiment indicator because it is related to investor confidence…Although it should not be used as a market timing tool, the implication is contrarian bearish,” Suttmeier says. ”Peaks in NYSE margin debt preceded peaks in the S&P 500 in both 2007 and 2000.”
It’s no surprise people have been taking on more risk as the market has moved to record highs. But the question is what happens when the easy ride higher turns south and some of that margin debt turns into margin calls?
A potential pitfall for those trading “on margin” is a sharp decline in stock prices, which can expose investors to margin calls, requiring them to post additional collateral lest their brokers sell their securities to cover the debt. A wave of margin calls can worsen selling pressure on stocks and was seen as partly to blame for the market’s woes during the financial crisis.
“It’s rather alarming to see NYSE margin debt just shy of its all-time high as of the March reading,” Cullen Roche of Orcam Financial Group wrote on the Pragmatic Capitalism blog (hat tip Business Insider). ”My guess is we’ve actually already surpassed the all-time high though we won’t officially know until April data is released.
“Fun times knowing we live in a world that is built on such a fragile foundation.”
–John Kell contributed to this report.
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