Investing with the Moon

Posts Tagged ‘margin debt’

Putting the QE toothpaste back in the tube

Posted by Danny on November 19, 2018

Last year I wrote an article on what to look for when the Fed unwinds its QE program: Quantitative squeezing – what you need to know.
Since the start of QT (quantitative tightening) the stock market is more or less flat and long term bonds are down about 10% yoy.

Let’s have a look at how the unwind is progressing and detect possible implications for investors.

The Fed’s balance sheet remains the main chart to watch (


From $4.46T a year ago the balance sheet is down to $4.14T, or an unwind of $320 billion. At this rate it would take about 10 years to get to a balance sheet that is back in line with the levels prior to 2009. As I pointed out last year, that’s not going to happen. Trying to put all the QE toothpaste back into the tube would create an economic crisis that is worse than the one they claim to have “solved” with their QE program.

I pointed to excess reserves held by commercial banks as the prime candidate to pay for the unwind. Here is the current situation (


From $2.2T excess reserves a year ago the banks are down to $1.75T. That’s a reduction of $450 billion. It does look like those excess reserves are indeed picking up the QT tab. But the interesting thing to note is that a $320 billion QE unwind came with a $450 billion reduction in excess reserves. A reduction at this rate could continue for another 3 years, bringing the Fed balance sheet to around $3T, but that would still be three times higher than it was before the crisis. Essentially, the excess reserves of banks are back down to late 2011 levels already, with the Fed’s balance sheet still $1.3T above its late 2011 levels. This is a strong indication that only a partial unwind of QE will be possible.

I also keep an eye on commercial banks’ holdings of government paper (


There is only a small rise from $2.49T a year ago to $2.56T now, an increase of $70 billion. This means banks are not showing much appetite for the debt paper that the Fed is unwinding, which is what I expected.
How about foreign buyers? Official foreign holdings of US treasuries were around $6.3T a year ago and are down to $6.2T now. Largest holders China and Japan have reduced their holdings and Russia has sold almost all its US treasuries. Predictably, those foreign buyers are also refusing to become QT bagholders:

This weak demand by major participants is why longer term treasury bond prices are down 10% over the year:


How about cash on the sidelines held by stock investors? The data are now here:
Stock investors have about $340 billion in cash and $650 billion in margin debt. Not much change. With those numbers we can’t expect stock owners to play much of a role in a $3T QE unwind. If anything they may panic alongside bond holders at some point, because margin interest rates go up together with rising Fed funds rates.

The question becomes: how much more QT can be done before it causes global bond market stress and starts choking the economy? We may be reaching that point already. If Europe and Japan start their own QT it could become even more interesting.

My guess is that QT in the US will be stopped (paused) as soon as excess reserves at commercial banks approach zero. It may be stopped even before that point. Stock and bond markets could show a very positive response to any such announcement. That’s going to be a wild card for investors in the year(s) to come. At some point it will be concluded that it is more desirable to freeze central bank’s balance sheets at their elevated post-2010 levels. Europe, Japan and China may never start their own QT (or only do a small symbolic reduction) because their economy remains too weak to take it.

A possible side-effect of doing too much QT would be an unexpectedly strong US dollar because it makes dollars more scarce.

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Is margin debt too high?

Posted by Danny on September 8, 2014

The first week of September has been more or less flat in the US stock markets. Once again we see a lot of observers call for the next crash or bear market based on all kind of indications. Today we will join the dance and take a look at margin debt, but let’s start with the current chart for the Nasdaq (click for larger image):


As expected, the market is consolidating its recent rally. As long as the Nasdaq stays above its July highs it will be well positioned for another push higher once the Earl and MoM indicators bottom out. That could take another week or so. On the upside, the 4700-4800 area is coming within reach. To the downside a drop to 4350 is possible if we get a deeper pullback. Both are possible, but this market has shrugged off a lot of “bad” news this summer, suggesting that the path of least resistance remains up.

Despite new record highs investors keep seeing plenty reasons why the market “should” go down: the Fed is tapering, the VIX is too low,… and this NYSE margin debt chart has popped up everywhere last week (click for larger image):

margin debt

Is this something to worry about? Let’s have a look. The data on which the chart was based can be found here. More complete FINRA data (combines Nasdaq and NYSE) can be found here. Based on the FINRA data there is currently a total $499 billion in margin debt versus $334 billion in free credit balances, making for a net margin debt of $165 billion. That’s about 1% of GDP and only 0.6% of the current $26 trillion market cap (Nasdaq + NYSE).

Comparing this with earlier market peaks:
* October 2007: margin debt $345 billion vs free credit balances of $343 billion (NYSE)
* March 2000: margin debt $279 billion vs free credit balances of $150 billion (NYSE)
* Aug 1987: margin debt $42 billion vs free credit balances of $4 billion (NYSE)
* 1929: gross margin debt reportedly reached 12% of GDP, almost 5 times higher than today (source)

We see no consistent pattern in these peaks. In 1929 gross margin debt was 5 times higher than it is now. In 1987 gross margin debt was 10 times higher than available free credit balances (which means there was very little cash to absorb any panic selling). And in October 2007 there was almost no net margin debt at the peak, there was actually more cash than there is now.

Also note that in 1984 gross margin debt was more than double the “normal” rate seen in 1970s. But stocks just kept going up for another 15 years.

It looks like margin debt is a very unreliable indication. This could be for a number of reasons:
* Current margin debt rates are extremely low, as low as 0.59% for large accounts (source). With many stocks/bonds yielding 2%, 5% or more it cannot be a surprise that margin debt is higher than average. Some investors are simply taking the free lunch that the central banks have been handing out.
* New instruments may make free credit balances look lower than they actually are. With transaction costs much lower than 10-20 years ago, an investor who sells stocks with the intention of buying them back after a few weeks, may now park the money into an ETF like $SHY rather than stay in cash for a few weeks. This can have the effect of making net margin debt look higher than it is.
* Inverse ETF make it possible to hedge a portfolio without going into cash. An investor can even use margin to hedge his portfolio with inverse ETFs. That throws a monkey wrench into the margin debt equation. Rising margin debt is no longer what it was 20 years ago.

We can always find good looking reasons and justifications for being bearish. Charts like margin debt look convincing, but are they? Margin debt could easily reach $1 trillion before this bull market dies. Nobody knows.

Good luck,


Posted in Financial Astrology, Market Commentary | Tagged: , | 2 Comments »

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