This is the only NYSE margin debt chart that matters

Much has been made in the press about how NYSE margin debt is at an all-time high, suggesting investors are overly optimistic.

However, the stock markets themselves are also at all-time highs – so perhaps the level of debt on margin isn’t telling us much that we don’t already know.

An article on the Philosophical Economics blog (reported by Josh Brown) explains the mechanism by which increases in the stock market translate into increases in margin debt:

Now, why does total margin debt increase with level and total market capitalization? There is a simple and intuitive answer. In any environment, a certain percentage of investors borrow against their portfolios. They borrow for several reasons. Examples: (1) They may be engaged in investment strategies that hedge and reduce risk by applying leverage to uncorrelated assets. (2) Margin debt may be the cheapest type of debt they have access to, so they can use it to pay off other more expensive debt. (3) They may be waiting for the money to arrive at a broker and need temporary cash to fund their purchases. Or (4) they could just be really bullish and really reckless.

We should expect the amount of margin debt taken on by these investors to vary depending on the size of the portfolios they are borrowing from. Thus, it is to be expected that total amount of margin debt existing to vary with the total stock market capitalization (the sum of the value of all equity portfolios). That’s pretty much what we see.

This brings us to the only chart of margin debt that matters: NYSE margin debt as a percentage of market capitalization, which shows how margin utilization is growing. relative as stock prices rise.

nyse margin debt cotd

Philosophical economics

Why has this metric increased? Philosophical Economics attributes it to the changing investment landscape:

Hedge funds have grown significantly since the early 1990s. The strategies they employ to smooth and maximize their risk-adjusted returns involve more leverage than the rest of the market has traditionally used.

Additionally, the cost of borrowing relative to a portfolio has come down significantly since the early 1990s. Borrowing on margin is now cheaper than it has ever been, not only because interest rates are at record highs, but also because competition in brokerage has produced a result where clients are offered much better terms.

Finally, with the development and massive expansion of online commerce, wallets are easier to monitor and adjust quickly. This reduces the stress of being on the sidelines.

Learn more about philosophical economics »

More from Business Insider

Comments are closed.