On the most recent edition of The Crash Proof Retirement Show, Phil Cannella discussed the growing problem of margin debt in our country—and what makes this increase so dangerous to investors. Cannella explained the debt cycle and how it tends to predict impending market corrections or crashes.
Last week, Business Insider reported the final numbers from April—when margin debt reached $500 billion for the first time in history. Aside from being an all-time record, that figure also means that margin debt has now reached a level where it equals more than 25% of the entire value of the S&P 500!
“If you have a portfolio made up of stocks and bonds, you can get a sort of loan on that collateral called a margin loan,” explained Phil Cannella. “It’s like an equity loan on your portfolio.”
For example, the owner of a stock portfolio worth $500,000 might be able to borrow an additional $300,000 or so to fund additional stock purchases, because he doesn’t want to sacrifice or sell any of his current holdings. In turn, these purchases inflate the market, allowing additional investors to borrow money to fuel stock purchases. Like most financial markets, it’s cyclical.
So what’s the issue? When stock prices drop, suddenly the brokerage houses get shyer about lending money for additional purchases. Traders who’ve ‘maxed-out’ their credit, so to speak, are forced to sell stocks to re-pay the margin loans. And when the level of margin debt is as high as it is in 2015, it means a whole lot of selling all at once, which speeds up the market correction. Again—it’s cyclical.
“These accounts are very dangerous,” cautioned Phil Cannella. “When margin debt exceeds 2% of the GDP, a market crash tends to follow.”
Indeed, in both 2000 and 2007 margin debt exceeded this level, followed by the crash of 2002 and the Great Recession starting in 2008. Today, margin debt stands close to 3% of total GDP—and not coincidentally, the stock market has been reaching all-time highs.
“There’s yet another indicator that a market crisis could be looming,” summarized Phil Cannella.
Tune in to The Crash Proof Retirement Show every Saturday at 11 a.m. on Philadelphia’s number-one talk station, Talk Radio 1210 WPHT-AM. Listen as hosts Phil Cannella and Joann Small report on the pressing issues and news that affect your retirement.