US stocks are being bidded up to stellar highs by investors borrowing a record amount of money, a move which is ratcheting up concern about the risk of a sharp correction.
While the S&P 500 index hit a closing high at the end of February, margin debt (money borrowed to purchase stocks) hit a record level in January, according to data from the New York Stock Exchange (NYSE).
Margin debt now stands at $451bn (£270.9bn) on the NYSE, a rise of more than 20 per cent in the past 12 months, outstripping 2007’s peak of $381bn and 2009’s low of $173bn.
This is driving investors to question the sustainability of current valuations, especially in the biotechnology and technology sectors, and to ask whether the increase in margin debt could be a warning flag for an imminent bear market.
James Lamont, managing director and product strategist in BlackRock’s global equities team, says that margin debt is one of a large number of indicators his team tracks and that high levels of debt are always a risk and a worry.
“As long as economic and earnings growth are positive, we expect equities to deliver better returns than fixed income and this is true in the US, as well as elsewhere,” he says.
“On a relative basis, compared to other equity markets, margin debt is one of a number of factors that make us rather cautious on the US market. Note also that NYSE new issuance is also back to the 2000 highs.”
Evan Moskovit, ING Investment Management’s head of global investment grade credit, says the increase in market levels is a result of an improving economic and regulatory outlook, as well as the tremendous amount of cash searching for income and return.
“We don’t believe the market return is a direct result of the use of leverage,” Mr Moskovit explains. “‘Borrowed’ money can be utilised to take ‘long’ as well as ‘short’ positions, so looking at the level of borrowing does not really tell us anything – further analysis is warranted. Borrowing can be used in different ways.”
He is reassured by the improvement in regulation since the 2008 credit crisis, insisting that “global financial institutions have never been in better shape from a leverage standpoint.”
Old Mutual Global Investors (OMGI) says its tracking of NYSE margin debt shows that borrowed money represented 2.8 per cent of the S&P 500 index’s market capitalisation at end January 2014, fast approaching the previous peak of 3 per cent in 2007-08.
OMGI’s figures also show that mutual fund investors pulled $14bn from domestic equity funds in 2013, yet NYSE margin balances rose $80.8bn during the same period.
Hinesh Patel, strategist in OMGI’s fixed income and macro department, says: “Herein lies our main concern. If ‘borrowed money’ is now the marginal driver for the S&P 500 index, then we need to be braced for additional volatility going forward.”
OMGI is also concerned by Japan, but more sanguine on Europe. In Japan, OMGI’s analysis shows a ‘borrowed money’ equivalence to 8 per cent of the Topix index at the end of January 2014 –off the 2000 and 2006 highs of 11 per cent, but still significant.