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Bullish Investors Push Margin Debt Levels to Record

Feb 27, 2018

Using leverage to speculate on stock markets can be a very damaging approach. Warren Buffet is certainly not an advocate, and was recently quoted saying that it is “crazy in my view to borrow money on securities”. The pursuit of higher returns, however, has led to a growing number of investors who are willing to take on debt attempting to capitalize on the bullish sentiment populating equity markets. But as Michael Wursthorn explores in his piece “Investors’ Zeal to Buy Stocks with Debt Leaves Markets Vulnerable”, buying on margin to speculate on equities may be compromising the stability of these markets. This potential threat, however, has not deterred investors from borrowing at historical rate.

Using debt to improve portfolio returns is not a new concept, but it is one that seems to be gaining momentum. By the end of 2017, institutional and retail investors collectively held a record $642.8 billion in margin debt. Investors who have equity dominant portfolios often subject themselves to the greater volatility that naturally exists in equity markets. When equity markets are prospering, it can become tempting for investors to increase their positions by buying on margin. This strategy is only successful, however, if equities continue to rise in value so that investors can cover their obligations. When market volatility caused investors to begin selling off earlier this month, a small dip was intensified by debt-heavy investors covering what they owed. One of the faster ways to raise the liquidity necessary to meet their obligations was to sell shares they had recently purchased. So many investors had used a leverage strategy to buy equities that this became a significant market driver. Brokerage firms are recognizing the danger their clients are in, and have begun to act.

Companies such as Merrill Lynch and E*TRADE benefit from margin loans made out to clients through the interest they receive. Even these firms, however, have begun to recognize the danger that many clients are getting into. Merrill Lynch banned clients from buying volatility tracking ETFs and E* trade raised its investor margin requirements. The fact that organizations profiting off margin loans are attempting to limit customer exposure to the risks is a clear indicator of the how serious the situation has become.

To read the article cited click here.