Few things evoke fear in markets like a margin call. Now there are signs that many U.S. stock investors are ill-prepared to deal with one.
The issue is net cash in equity brokerage accounts, seen by some as a proxy for how well-cushioned traders are from forced liquidations if stocks start to plummet. It’s calculated by subtracting the amount of debt used to buy securities from money in an account that’s available to buy more.
And right now, it’s perilously low.
The deficit just reached $317 billion, the widest ever, according to New York Stock Exchange data compiled by Sundial Capital Research Inc. The previous record was set in January, right before the S&P 500 Index suffered its first 10 percent correction in two years.
Cash “seems to provide less of a cushion for any decline in the value of stock,” Jason Goepfert, president of Sundial Capital Research Inc., wrote in a note to clients. “That is clearly concerning.”
There are few topics in the market subject as much demagoguery as margin debt, and a standard critique over the the period of the bull market has been that it’s at untenable levels — $652 billion, by the NYSE’s last count. What’s usually lost in the discussion is that such debt basically always rises with the value of equities — the two are virtually synonymous since one collateralizes by the other.
What’s bad is when the expansion of margin comes untethered from the slope of equities, signaling people are taking out loans even faster than stocks are appreciating. That happened in the final year of the last two bull markets, when margin loan growth outpaced share gains by twofold in 2007 and almost four times in 2000.
Nothing like that is happening now. At the same time, a similarly dire picture is evident when cash credits in brokerage accounts are taken into consideration. Available for investors to withdraw at any time, for any purpose, they include proceeds from short sales and extra buying power held in margin accounts. Last month, they fell 3.3 percent to $335 billion, the lowest level in four years.
Think of the money as assets on a balance sheet and stock loans as liabilities. As traders withdrew cash while at the same time raising debt, their financial health, or in Sundial’s term “net wealth,” deteriorates.
“Debt alone doesn’t tell the whole story,” Goepfert said. “The new record in negative net worth is most concerning, just not as concerning as it would be if the growth in debt was more extreme. The latest drop in net worth is due more to a drain of cash out of accounts as opposed to an increase in debt. Maybe that’s just as worrisome.”
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