Market Overview Analysis by Lance Roberts covering: S&P 500. Read Lance Roberts's latest article on Investing.com
In the most recent report from FINRA, margin debt levels have surged as bullish investors leverage their bets in the equity market. The increase in leverage is not surprising, as it represents increased risk-taking by investors in the stock market., in the short term, reflect investor optimism. In other words, as prices increase, investors rationalize why paying more for current earnings is rational.
People are back to having to take on more risk to get return. At Oaktree, we are back to a cautious approach.The prospective returns are low on everything.” However, leverage also works in reverse, as it supplies the accelerant for more significant declines as lenders “force” the sale of assets to cover credit lines without regard to the borrower’s position.The issue with margin debt is that the unwinding of leverage is NOT at the investor’s discretion.
The chart shows the relationship between cash balances and the market. I have inverted free cash balances, so the relationship between increases in margin debt and the market is better represented. In the short term, exuberance is infectious. The more the market rallies, the more risk investors want to take on. The issue with margin debt is that when an event eventually occurs, it creates a rush to liquidate holdings. Since margin debt is a function of the value of the underlyingthe forced sale of assets will reduce the value of the collateral. The decline in value then triggers further margin calls, triggering more selling, forcing more margin calls, and so forth.
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