By Yaser Anwar, CSC of Equity Investment Ideas
I’m a big fan of the Economist, in my opinion its the best magazine one can read and is the only one I enjoy reading cover to cover. They’ve got a great blog too, Free Exchange.
Free Exchange had an excellent post on margin debt, which I’d like to re-print.
Financial writer Daniel Gross sounds an alarm over margin trades. He quotes the Wall Street Journal:
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
And adds:
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.
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.
Margin ownership may be a leading indicator of a bubble, of course. But it’s a little early to panic, especially for someone who’s just written a book about market bubbles. I’ll start worrying when elevator boys offer me stock tips.
In the past some of my favorite blog authors have talked about this issue-
Feb 27th 07: Bill Rempel- More On Margin Debt
Jan 16th 07: Barry Ritholtz- Margin Debt Up 22%
Nov 04th 07: Brett Steenbarger- Margin Debt: An Indicator That Hasn’t Lost Its Value
What’s the relevance of all these past posts? Well, for one, they talk about various issues which investors need to be cognizant of when looking at margin debt. Sure a historical sample of margin debt is great, but markets are constantly changing and the trio talk about the issues to be considered.
By Yaser Anwar, CSC of Equity Investment Ideas
I’m a big fan of the Economist, in my opinion its the best magazine one can read and is the only one I enjoy reading cover to cover. They’ve got a great blog too, Free Exchange.
Free Exchange had an excellent post on margin debt, which I’d like to re-print.
Financial writer Daniel Gross sounds an alarm over margin trades. He quotes the Wall Street Journal:
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
And adds:
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.
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.
Margin ownership may be a leading indicator of a bubble, of course. But it’s a little early to panic, especially for someone who’s just written a book about market bubbles. I’ll start worrying when elevator boys offer me stock tips.
In the past some of my favorite blog authors have talked about this issue-
Feb 27th 07: Bill Rempel- More On Margin Debt
Jan 16th 07: Barry Ritholtz- Margin Debt Up 22%
Nov 04th 07: Brett Steenbarger- Margin Debt: An Indicator That Hasn’t Lost Its Value
What’s the relevance of all these past posts? Well, for one, they talk about various issues which investors need to be cognizant of when looking at margin debt. Sure a historical sample of margin debt is great, but markets are constantly changing and the trio talk about the issues to be considered.
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