Home Stock Market Commentary Margin Debt Deleveraging In The Stock Market – Mike Swanson

Margin Debt Deleveraging In The Stock Market – Mike Swanson

Margin debt tends to grow and even explode in a bull market and then shrink in a bear market. Margin debt peaked to a new record high in October of 2021, a few months before the S&P 500 and Nasdaq topped out, and has been slowly going down ever since. You can see what it has done with this chart from the folks at AdvisorPerspectives.com.

There is a really important reason why margin debt grows and shrinks like this.

When people take on margin what they are doing is borrowing money against the value of their brokerage account to buy more stocks or assets in the account.

If someone has say $50,000 most brokers will let them borrow up to $50,000 more to buy more assets in their account.

As long as their accounts rises in value that is fine, but if it starts to drop they will compound their losses and at some point the broker will force a liquidation in the account in order to prevent their customer from actually owing them money.

It’s easy to talk about the subject of margin debt and talk about people who engage in wild risky trading in the markets, but most of the margin debt is actually taken on by large institutional investors.

It is very difficult for large investors to beat the stock market via pure stock picking.

The performance of the S&P 500 in a bull market can become driven by a few stocks helping to push it up, so to beat the market can require being heavily invested in just those stocks.

For years we heard about that “FAANG” stocks as must own stocks and people piled into them for years on end.

Now there are a lot of bagholders in them.

Jeff Bezos actually sold billions of his Amazon stock at the end of 2021 and Elon Musk sold billions of his Tesla shares too, while the stocks began this year as among the most widely owned stocks among everyone in the markets.

That is one reason why these stocks, such as Facebook, Amazon, and Google are under performing the S&P 500 this year.

But one way that many institutional investors, such as hedge funds, try to beat the market in a bull market is by simply using margin to buy more.

So, as the market goes up they often will simply pyramid and take on more margin.

It works until the bull market ends.

Then as the market declines they have to get off the margin.

So, bear markets, like we are in now, bring with them margin deleveraging.

But there is another interesting aspect to this.

If you are in a bear market like we are in now – the S&P 500 is still down 18.57% year to date, despite this October rally – all you have to do to beat the market is reduce your risks. You do the opposite of going on margin, and pair back your investing positions.

Right now one can make 3-4% by simply buying 30-90 day Treasury bonds and CD’s. That’s not to say I would put money into bonds funds, as I would not myself.

If you are a money manager with a positive return this year than you are a hero.

That’s a return that beats a market that is in a bear market like we are seeing this year.

And anyone doing that contributes to the overall deleveraging process that is going on in the markets this year.

If the goal is beating the market, it isn’t hard to do if one just reduces the risks they are taking on in their accounts. Margin in that sense is useless in a bear market.

The alternative is jumping in and out of the markets, trying to day trade them, hoping to hit it big, which can easily lead to manic trading and even more risk taking if one is not careful or experienced at it.

That’s a hard game and most people make the mistake of trying to go against the dominant market trends by playing bear market rallies over and over again, which they are encouraged to do by stock market gurus and TV talking heads that tell their audience what they want to hear – that the bull market is just right around the corner so buy.

But playing rallies in a bear market is just as tough as trying to short sell or buy put options on stocks in a bull market.

If you are new to this website then you need to subscribe to my free stock market update list by clicking here.

Some positive changes are happening here.

Over the weekend I upgraded the home page for WallStreetWindow to improve it.

I also added a comments box to the bottom of the posts.

It does require using a Facebook account to make a comment – that’s to control spam and use an easy system so that you don’t need a password from this website to make comments.

Let me know your thoughts on the markets or any questions you may have in the comments box below.

Test it out and say hello.

-Mike