The stock market leverage peaks, the debt margin up 42% year-on-year. Fed warns of high leverage ratio of “young retail investors”

“A potentially destabilizing result could emerge if the appetite for high risk among retail investors were to decline rapidly.” But what the hell.

By Wolf Richter for WOLF STREET.

Only a portion of the leverage in the stock market is tracked and disclosed on a monthly basis. Much of the leverage occurs in the shadows, including securities lending (SBA) that banks may or may not disclose on a quarterly or annual basis; leverage at the institutional level as with hedge funds, an $ 8.5 trillion industry; and the leverage associated with options and other equity derivatives.

It’s only when something explodes that we can see bits of that leverage emerge in all its glory, like when Archegos imploded earlier this year.

The only leverage data we get on a monthly basis is broker margin debt, reported by FINRA. And we have another doozie: Market margin debt soared $ 33 billion in October from September to another all-time high of $ 936 billion, up $ 277 billion or 42% from to a year ago and 67% compared to October. 2019

The increase in margin debt has become an outlier compared to previous years, with an increase in margin debt of 42% year-on-year and 66% in two years, summed up by this graph of changes from one year to the next. year over year, with the period since March 2020 in red:

This type of stock market leverage cannot predict when the market will collapse. What he predicts is that when this market drops enough, it will trigger massive bouts of forced selling as margin calls come out, and leveraged investors must sell stocks to pay off their margin debt. , which then drives prices down further. , which then triggers more forced sales, and more fears of forced sales, as the portfolios are liquidated, thus accelerating the fainting.

This is why leverage is a risk for financial stability. And why the Fed continues to talk about leverage in its financial stability reports.

But apparently no one at the top of the Fed – let alone Powell and the other FOMC members – ever reads these financial stability reports because the FOMC, on the other side of their mouth, keeps pushing more and more. leverage with its interest rate. repression and money printing.

Margin debt is the big accelerator of the upside, as the borrowed money enters the market and creates new buying pressure.

And the debt on margin is the big accelerator of the decline, because this borrowed money is taken out of the market and disappears by paying off the debts, thus creating selling pressure.

High levels of stock market leverage is one of the prerequisites for a sell off. It’s hard to have a massive sale without a lot of leverage.

In his Financial Stability Report, published this month, the Fed particularly warns against high leverage among young stock market investors.

“The median debt ratios of young retail investors are more than double that of all investors, leaving these investors potentially more vulnerable to large fluctuations in stock prices because they have a greater debt service burden.” the Fed said in the report.

“In addition, this vulnerability is magnified as investors now use more and more options, which can often increase leverage and amplify losses,” he said.

High leverage is a sign of a high and growing “risk appetite”, as the Fed calls it. And regarding these investors’ risk appetite and reliance on social media, the report warns:

“A potentially destabilizing result could emerge if the appetite for high risk among retail investors quickly recedes to more moderate levels,” the Fed said.

But what the hell.

On the other side of its mouth, the Fed is still pushing short-term interest rates close to zero, and it’s still engaging in large-scale money printing to crack down on long-term interest rates. and further heat up that appetite for risk that she believes could retreat, and when it does recede, could produce “a potentially destabilizing outcome.” So…

Here’s the long-term view of margin debt. As the purchasing power of the dollar declined over the period, it is not the long-term increases in absolute dollar amounts that matter, but the sharp increases in margin debt. before the sales, and the magnificent increase currently underway:

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