The bull market in stocks turned five in March, ushering in a new round of hand-wringing about a possible correction. With global economic growth crawling at a snail’s pace, bearish observers note the S&P 500, up 170 per cent since 2009, has plateaued since January. Over the same period, corporate growth stories like Amazon and Netflix have seen their share prices slump considerably.
Perhaps the most-discussed sign the stock market may be overshooting is the torrid growth of margin debt, or money borrowed against investors’ brokerage accounts. Under most circumstances, investors with an appetite for risk can borrow up to half the value of their stock positions, giving them a chance to effectively double their returns if they use the money to buy more stocks.
As of February, U.S. investors borrowed a record $466 billion in margin debt, the eighth monthly increase in a row, according to data compiled by the New York Stock Exchange. In Canada, figures kept by the Investment Industry Regulatory Organization of Canada show margin debt totalled $17 billion at the end of February, which represents both an all-time high and nearly double what it was at the depths of the recession.
Why does this matter? Previous margin peaks coincided with peaks in the stock market: in 2000, before the dot-com bust, and again in 2007, ahead of the financial crisis. According to bears, excessive borrowing to magnify stock returns goes hand-in-hand with rampant speculation. Plus, they argue, margin debt has a nasty downside—it magnifies losses because the money still has to be paid back, on top of portfolio losses.
Of course, not everyone believes today’s record margin debt is a foreboding sign. J.P Morgan recently argued it could be explained by a rise in the number of hedge funds, which favour leveraged strategies. However, the J.P. Morgan analysts found it more difficult to brush off a related measure called net debit, which subtracts cash and credits in investors’ margin accounts from the debt they owe. The last time net debit readings hit this level was February 2000—the very peak of the dot-com bubble.
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