The week starts off with an ominous article in the Wall Street Journal. Margin debt, or loans investors have taken out with their investments as collateral has hit an all time high. Higher than just before the 2000 bursting of the tech bubble, higher than just before the 2007 financial crisis.
Chart of the Week: Debt on the Rise
But of course, the value of those investments have gone up over time as well. $250 billion is not the same as it was a few years ago, let alone 17 years ago. As a percent of market cap, total debt is just under all time highs:
As long as stock markets rise, this means nothing. Where this presents a potential problem is
if when we have our next stock market correction. When stocks decline, investors not in debt have the opportunity to hold their investments through the turmoil. But investors who have borrowed against the value of their investments may be forced to sell if the value of their investments fall (called a margin call), this leads to more selling, which leads to more margin calls, which leads to more selling….
The Wall Street Journal article linked above says that equity values have to fall between 20 and 30% before margin calls will start.
How likely is that to happen any time soon? My favorite reference is a chart from the Capital Group:
Historically, 20% declines, enough to likely start margin calls with today’s record debt levels, have occurred once every 3.5 years or so.
It’s been over 8 years since our last one.
How to Invest From Here
Investors have been lulled into a sense of complacency lately. Markets have been calm, earnings have been solid and global events have failed to spook investors.
But the problem is; at a time when volatility is at an all time low, high debt levels pretty much ensure that can not continue.