The use of margin debt is an important indicator of market sentiment. Over the past year we have commented several times on how NYSE margin use in 2012 had moved higher than the manic levels seen just before the 2000 market crash and was fast approaching the peak achieved just before the 2008 market crash. This week we confirmed that in April, NYSE margin debt officially surpassed the previous all-time-peak from 2007 as the year-to-date QE rally year spurred participants to borrow more than $384 billion against their portfolios in April a jump of 29% over the same month last year. See WSJ: Margin debt hits a record, showing confidence
Confidence? How about madness? In one of the most dangerous and contrived, market environments ever, participants are virtually assuring the likelihood of extreme capital evaporation. This trend also presents clear and present danger for un-levered investors who are not using margin debt, but are trying to follow the conventional wisdom and hold equity assets for dividend income. Forced liquidation selling is always the eventual outcome of high margin periods once asset prices begin to weaken. And this tanks the asset prices of both those who are using margin, and those who are not but are trying to be patient “long-term investors.”
But here is the part of the story that really screams nightmare. Apparently some financial
advisers sellers have been recommending that people use margin debt to fund other “investments”:
“…advisers say that margin debt can be a cheaper and easier way to borrow than a traditional loan, so they are recommending margin borrowing for uses like home renovation and business expansion.”
Wow! Make long-term, illiquid allocations by borrowing it on margin debt that can be called on a moments notice when securities prices fall. With financial advice like that who needs enemies. Can you say financial suicide waiting to happen? It would be better to take your cash out and burn it in a bonfire in your backyard. At least then you could get some enjoyment and heat off of its destruction.