“Investors Have Begun To Reduce Leverage” – BofA Spots “Bearish Signal” In Margin Debt

Research analysts publish dozens of complex charts that illustrate the bubble of everything continues to inflate away as central banks expand their balance sheets at record paces. These monetary wonks have distorted traditional indicators and made fundamentals obsolete, leading markets into a dangerous melt-up on a post-COVID basis. In our minds, and what we want to convey to readers: simple is better, and that’s why we’re focusing on margin debt. 

Margin debt – the amount that individuals and institutions borrow against their stock holdings as tracked by Financial Industry Regulatory Authority (FINRA) – has soared to record levels since the COVID lows of 2020. It’s a simple indicator of stock market leverage. Turning points in markets develop when leverage is unwound, and Bank of America’s Stephen Suttmeier has spotted “potentially a bearish peak for margin debt in June 2021.” 

“Rising leverage tends to confirm US equity rallies. It is not new record highs for margin debt that we worry about. We get concerned when margin debt stops rising to suggest that investors have begun to reduce leverage,” Suttmeier said. 

FINRA reported that July was the first decline in margin debt since the bottom of the equity market in March 2020. FINRA margin debt plummeted to $844 billion (down 4.3%) from a record high of $882 billion in June. Although peaks in margin debt don’t always coincide with tops, he points out the decline results in weaker price action for the S&P500. 

A major S&P500 top was put in during the Dot Com and GFC when margin debt violently reversed. There have been three instances of drawdowns in margin debt with corrections then immediate V-shape recoveries in the main equity index post-GFC. In June, margin debt peaked then reversed in July, and Suttmeier is extremely “concerned” about this trend.

The equity analyst identifies 21 margin debt peaks using FINRA and Global Financial Data back to 1929 and determined the S&P500 generally trades weaker after a margin debt peak. 

“The SPX tends to be much weaker and is less likely to trade higher for the 1-month through 24-month periods after a peak in the margin when compared to SPX returns for all periods back to 1928,” Suttmeier said 

Another way to look at margin debt is through a 12-month rate, which has produced a “bearish signal” for equities.  

The 12-month z-score also shows margin debt was at an extreme, a little over two standard deviations over the mean. The excessive borrowing was fueled by central bankers creating a low-volatility regime which drove retail into meme stonks. 

The free credit balance available in customer’s cash and margin accounts at a broker-dealer fell to a record low in late December. This means investors are leveraged to the teeth. 

During past margin spikes, investors were swept up in the euphoria phase of easy money. Today’s over-exuberance is in the “meme stonk” craze and ESG stocks. 

Michael Burry, the famous hedge fund manager who bet against the housing market in 2008, had caused a stir on Twitter not too long ago when he said, “the mother of all crashes” was nearing. 

Burry warned about meme stocks, such as GameStop and AMC Entertainment Holdings, that “We’re out of new money available to jump on the bandwagon.”

Over the decades, there’s always been a tipping point for markets when margin debt reverses and causes equities to waterfall. A correction in stocks could trigger margin unwinds that would result in a crash.