Chart of the Week: The Calm Before the Margin Call

But something still doesn’t feel right. So I thought I’d take a look at what’s actually going on beneath the surface.

And one chart in particular caught my attention because it tells me that this rally is running on borrowed confidence.

As you can see, US margin debt just rose to a new all-time high.

What does it mean for you and your portfolio?

When people borrow more to buy stocks, it usually means they feel confident. Sometimes that trust is justified. Other times it’s a warning sign.

In this case it could be both.

Borrowed money drives the market

In July I told my Extreme fortunes readers who: “We are in a phase of low volatility and higher levels, led by retail momentum.”

That hasn’t changed.

On the surface, everything looks good today. Stock prices continue to rise and corporate earnings appear solid.

In other words, the path of least resistance at this point is to take a “hold steady” approach.

But beneath the surface, rising margin debt is like adding an accelerant to a fire.

When investors buy on margin, they increase their exposure. That means wins can be bigger, but so can losses.

In a calm, steady rally, that’s fine. But once volatility increases or market sentiment sours, leverage quickly becomes a problem. If we are hit with surprise inflation numbers, or if the rate rhetoric flares up again, or if the Fed becomes more cautious, all that leverage can make a small pullback seem a lot bigger.

In other words, margin debt won’t add fuel to the fire. But it will make it worse if it happens.

So what should you pay attention to?

If margins start to rise (meaning lenders see more risk) or if there is an increase in sell-offs (margin calls), then that’s when the ‘rut’ could shift to something much less friendly.

And if the market’s upside potential concentrates in fewer names while margin debt rises, that’s another warning sign.

Here’s my opinion

I’m not sounding the alarm yet. This card is a warning sign, not a red light.

In fact, I believe this rally can continue, and it is likely that we are still in that “grind up” zone.

But this graph tells us that our margin of safety has become smaller. The advantage remains, but getting caught when the tide turns is much more dangerous than it was a few months ago.

It is not a reason to exit the market, but rather a reminder that the next upward phase will require stronger fundamentals and broader participation…

Not just leverage and momentum.

Greetings,

Ian King
Chief Strategist, Banyan Hill Publishers

Editor’s note: We look forward to hearing from you!

If you have any opinions or suggestions about the Daily disruptoror if you would like to discuss specific topics, please email dailydisruptor@banyanhill.com.

Don’t worry, we won’t reveal your full name if we publish a comment. So feel free to respond!