There is no doubt that the U.S stock market is on a tear with the appearance that there is no end in sight to the party, particularly with the latest GDP report showing 4.1 percent growth. All that said, there is one worrying trend as you will see in this posting.
From the Financial Industry Regulatory Authority (FINRA), we have access to decades’ worth of key investment data. For the purposes of this posting, I have accessed FINRA’s margin statistics that you can find here. Let’s look at FINRA’s data for debit balances (i.e. margin debt) in customers’ securities margin accounts going back to February 2010:
As you can see, margin debt has risen from a low of $263.202 billion in June 2010 to a high of $668.940 billion in May 2018, an increase of 154.2 percent.
FINRA also records the free credit balances in customers’ securities margin accounts as shown here:
Free credit balances in margin accounts have actually changed very little over the past nine years, generally falling in the range of $160 million to $200 million.
If we take the two data sets and subtract the free credit balance from the margin debt, we get a picture of the overall size of the net margin debt as shown here:
Let’s look at what FINRA had to say about the risks of margin debt back in January 2018 when margin debt was a “mere” $627.4 billion (November 2017 data point):
“Your firm can force the sale of securities in your accounts to meet a margin call. If the equity in your account falls below the maintenance margin requirements under the law—or the firm’s higher “house” requirements—your firm can sell the securities in your accounts to cover the margin deficiency. You will also be responsible for any short fall in the accounts after such a sale.
Your firm can sell your securities without contacting you. Some investors mistakenly believe that a firm must contact them first for a margin call to be valid. This is not the case. Most firms will attempt to notify their customers of margin calls, but they are not required to do so. Even if you’re contacted and provided with a specific date to meet a margin call, your firm may decide to sell some or all of your securities before that date without any further notice to you. For example, your firm may take this action because the market value of your securities has continued to decline in value.
You are not entitled to choose which securities or other assets in your accounts are sold. There is no provision in the margin rules that gives you the right to control liquidation decisions. Your firm may decide to sell any of the securities that are collateral for your margin loan to protect its interests.
Your firm can increase its “house” maintenance requirements at any time and is not required to provide you with advance notice. These changes in firm policy often take effect immediately and may cause a house call. If you don’t satisfy this call, your firm may liquidate or sell securities in your accounts.
You are not entitled to an extension of time on a margin call. While an extension of time to meet a margin call may be available to you under certain conditions, you do not have a right to the extension.
You can lose more money than you deposit in a margin account. A decline in the value of the securities you purchased on margin may require you to provide additional money to your firm to avoid the forced sale of those securities or other securities in your accounts.
Open short-sale positions could cost you. You may have to continue to pay interest on open short positions even if a stock is halted, delisted or no longer trades.” (my bold)
Remember that selling assets that are no longer under your control can be an extremely painful experience. While the stock market appears to be on an endless journey upwards, as we found in 2008, no one (particularly not central bankers) saw this coming:
The unprecedented growth in margin debt is worrisome, particularly given that when the inevitable margin calls are made, the volatility in the stock market will be magnified as overly indebted Mom and Pop investors find that the system works against them. Margin debt could well prove to be the stock market’s Achilles heel.
Click HERE to read more and view the original source of this article.