“Margin debt” is increasing. It becomes a risk for the stock market.

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Using margin debt can magnify gains and losses. Above, a scene from the floor of the New York Stock Exchange.

Spencer Platt / Getty Images

Margin debt increased. This means that the risk to the stock market is increasing, a danger that has worsened with the recent fall in stock prices.

Margin debt – the amount of money traders borrowed to buy new stocks, using their stocks as collateral – hit near an all-time high. It stands at $ 936 billion, according to Yardeni Research, up 40% from the same period last year.

Using margin debt can amplify an investor’s cash returns, as a trader can hold a larger position using the same amount of their own money. But the same is true on the downside. If stock prices fall, the debt-stricken investor sees the value of their portfolio fall more than they otherwise would have.

The growing amount of debt is worrying, but even more worrying is the percentage of stock market value that debt represents. Margin debt currently represents 2.4% of

S&P 500

total market capitalization of $ 38 trillion. Just before the pandemic, it was around 2%. Admittedly, the current level of margin debt in relation to the market value is still below its peak, the 3.5% it reached during the financial crisis of 2008-2009. The lowest point since the mid-1990s was less than 2%.

In any event, the combination of growing margin debt and declining stock prices increases the risk to the market. When the value of the stocks that a trader buys on margin drops to a certain point, the broker who loaned the money requires the trader to deposit additional cash into the account. Either the trader has the cash on hand or he has to sell stocks to raise funds.

If the stock market drops enough, many traders will receive margin calls, which could force even more sells and lower prices. “The margin is at an all time high,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “This increases the possibility of more margin calls if we get more [market] weakness.”

This risk to the market is certainly higher than it was just a few weeks ago. The S&P 500 has fallen about 3% from its all-time high in November, affected by uncertainty over the effectiveness of existing vaccines against the Omicron variant, not to mention the Reserve’s announcement federal government that she could end the bond purchase she used. to support the economy sooner than expected.

A falling stock market is often a reason to buy. This time it could be a sell signal.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

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