Biggest dollar drop ever and one of the biggest percentage drops.
By Wolf Richter for WOLF STREET.
The only measure of market leverage that is reported monthly is margin debt at brokers, via FINRA. Much of the leverage in the stock market is unreported, such as securities lending, and even the banks and brokers that fund this leverage don’t know the leverage in the overall market, nor even their client’s leverage if that client is leveraged as well in other banks. Funds can be leveraged at the institutional level. There is leverage associated with options and other equity derivatives etc.
Leverage is the great accelerator of stock prices up and down. And the only part of the leverage we can see dip in January by the largest dollar amount ever and one of the highest percentages ever.
Market margin debt, after an all-time high during the Fed’s extravagance of money printing and interest rate repression that began in March 2020, plunged $80 billion in January from December, the largest decline in the dollar in the data, dating back to 1990, and the third consecutive month of decline, at $830 billion, according to FINRA today:
But the margin debt is still gigantic, with only a small portion having been unwound. The all-time high in margin debt during the Fed’s $4.7 trillion QE in 22 months was a historic outlier, peaking last October with a 67% increase over two years.
In November, the Nasdaq peaked as we now know in hindsight. Since then, it has fallen 16%.
But many top-flight titles have been totally crushed, one by one, many of them started to be crushed in February a year ago, with several dozen of these high-flyers down from 60% to more than 90 % from their peaks. And the leveraged bets of enthusiastic retail investors on these stocks were abruptly canceled, either voluntarily or via margin calls.
Margin debt is the big accelerator on the upside because it creates buying pressure with borrowed money, and on the downside because it creates forced selling pressure.
In percentage terms, margin debt plunged 8.8% in January from December, the biggest drop in data since key times:
The Fed is moving from QE to QT:
- March 2020: -12.1% (Covid Crash)
Euro debt crisis:
- May 2010: -9.1%
- November 2008: -18.1%
- October 2008: -19.7%
- August 2007: -13.0% (the financial crisis begins to resurface)
- March 2001: -12.1%
- December 2000: -11.6%
- April 2000: -10.4% (the dotcom crash begins)
Many of the best performing stocks have already been crushed: A good sample of the most hyped and best performing stocks are included in the ARK Innovation ETF [ARKK]. It is down 5.0% today at $64.80, the lowest close since June 15, 2020, and is down 59% from its February high of last year. Some ETF stocks have collapsed much more since their peaks, such as Twilio (-64%), Zoom (-72%) or Roku [-77%].
People who took on high margin debt to finance their holdings of stocks represented by the ARK Innovation fund either voluntarily liquidated at least some of their positions or were forced to by their broker – and this widespread forced selling accelerated the fall in the prices of these stocks:
High leverage in the stock market is one of the prerequisites for a sell-off.
In October, just before the selloff took shape on the Nasdaq, the Fed warned in its Financial Stability Report on high leverage among young retail investors: “The median leverage ratios of young retail investors are more than double those of all investors, making these investors potentially more vulnerable to large swings share prices because they have a higher debt service burden.”
“Furthermore, this vulnerability is magnified as investors now increasingly use options, which can often increase leverage and magnify losses,” the Fed said.
“A potentially destabilizing outcome could occur if retail investors’ high risk appetite quickly recedes to more subdued levels,” the Fed said.
Everyone knew it, and margin debt follows some of it, but it just took the Fed a while to figure it out.
From the long-term perspective of margin debt and its relationship to market “events”, it is not increases in dollar amounts that matter – given the effects of inflation – but large increases in margin debt before the fairs, and subsequent stock market sell-offs. But no increase has been more magnificent than that of 2020 and 2021, neither in absolute terms (dollars) nor in relative terms (percentage):
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