Chart shows margin debt for S&P 500 to August 2014.
The last time the S & P 500 dropped 10 percent of more was 2001. Rising right along with this huge equity bull-run these years has been margin debt, another term for leverage.
Leverage works both ways. It can make one lots of money and, if not well-managed, can likewise lose one chunks of money. According to data from the New York Stock Exchange as noted in the Financial Times, margin debt "peaked in February at $466 billion and stood at $463 billion in August."
So there's still a lot of it around. What's the significance? Well, investors love upside volatility when they're heavily margined, but downside volatility is a horse of another breed. The peak in margin debt in 2007 before the fat lady cleared her pipes was $382 billion. In early 2009 it cratered at $173 billion, per the Times.
Moreover, the Fed's ZIRP magic encouraged the use of margin owing to the lower carrying costs.When the Fed finally end QE, informally known as the punch bowl, investors will get, if they have not already, a sense of what it feels like to fly without a safety net.
During the Greenspan-run Fed, from1987 to 2000, Sir Alan exercised what became known as the Greenspan Put. When things got dicey he increased liquidity by lowering the Fed Funds rate, creating a negative real yield and thus encouraging risk taking to revive stock prices.
For some time now many market observers have viewed QE in a similar light. Buying on margin as noted can help boost returns. But huge downside volatility as happened last week squeezes margins and triggers broker margin calls forcing investors to sell, creating in the process more downside volatility.
Free lunches are only free until they aren't free anymore. And what a lot of investors don't apparently see is the Fed's huge QE program was a free lunch for many unless one was living on a fixed income.
t. man hatter
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