Is the rise in the use of margin in equity trading telling us something? Finance blogger Yaser Anwar suspects so, rounding up a spate of recent posts on the subject.
The Economist blog, Free Exchange, says there’s little to worry about in the short term, having picked up a rather alarming post on the Daniel Gross Moneyblog. Gross, in turn, was spurred to write by a Wall Street Journal article declaring:
“After rising 24.2% last year, margin debt, which is accumulated by investors who bet on stocks with borrowed funds, got off to a strong start in 2007. In January, it reached $285.61 billion as the Dow Jones Industrial Average gained 1.3%, passing the previous highest level of $278.53 billion, according to figures from the New York Stock Exchange. That record was set in March 2000, the same month that saw the Nasdaq Composite Index reach its highest closing on record.”
So Gross asks: “Anybody remember what happened in March 2000? Anybody care to guess when else in history margin debt, after several years of positive market returns, soared to really high and ultimately unsustainable levels? If you guessed 1927, 1928, and 1929, you’re right.”
Free Exchange says this is “just a tad overwrought.”
“For one thing, it’s a record only in nominal terms; if you factor in inflation, margin trading will need to reach $330 billion to surpass its 2000 record. For another, margin trading ain’t what it used to be. In 1929, people were buying stocks on as little as 10% margin; now buyers must put up half the value of their trade on margin, and individual brokers can require more. That’s a five-fold difference in the amount of implied leverage in the market.”
“And, of course, there’s the question of what percentage of the stock market’s value that margin represents. In 1929, it is estimated that almost one-third of the stock market’s value was owned on margin. These days, the Wilshire 5,000 index, which is the broadest available index of the three major American exchanges, has a total market capitalisation of about $17.5 trillion. That would make margin ownership responsible for, at most, 5% of current market cap. Hardly a meltdown in the making.”
For what it’s worth, FT Alphaville suspects this debate is a tad US centric and also ignores the leverage being built up in other (modern) asset classes. The effect is to render historical comparisons virtually meaningless.
And is it really the case that US investors “have to put up half the value of their trade on margin?” British contract for difference and spreadbetting houses will typically accept 10-15 per cent for highly liquid stocks, such as members of the FTSE 100. A 50 per cent requirement only kicks in with the most volatile small caps.
And as for other asset classes — how about the new army of retail punters playing the foreign exchange markets at 200 times leverage or more? How does that play in historical context?
