When I think of him leverageI always imagine the scene of the climber without a rope. If you are going up safely, you may go slower. But if you go at full speed propelled artificially and without a rope and, suddenly, the system screws up, the pineapple is enormous and can be lethal.
Well, here is the information. I show you the variation of Margin Debt on the NY Stock Exchange with a two-year rate. In simple words, how much has the investor leverage in 24 months.
When the dI hope that the broker They lend to people to invest in a leveraged way begins to shoot up to rates that exceed 60%, we enter what I call the “EYE” zone. Because? Well, it is clearly an indication of a overheating. It happened before the fall technology bubblejust before the falls of the great recession of 2007-2008reappeared at the end of 2021; Yeah, just before the falls of 2022… On all of those occasions, the market ended up correcting quite abruptly. He is the doped climber.
Source: Carlos Arenas Laorga
Now, although it is an indication that I observe from time to time, and it is quite reliable, it is not at all the oracle of Delphi. I say this because I have already heard that we are going to hell because indicators like this predict it.
To begin with, I want to remember that economic science is a social science. That is, of the human being. And just because something has happened in the past does not mean that it will happen today, much less in the future. Rising leveraged debt is a symptom, not an automatic cause of decline. A child’s fever may be worrying, but it does not imply serious illness or death.
Yes, a strong increase in leverage usually coincides with what we know as exuberance. Many confident investors, Warren Buffett increases liquidity… As they used to say: when the shoeshine boy talks to you about his investments, sell.
In this case a surprising thing happens. I mean, this scary indicator comes from the hand of some business results that support market valuations. Furthermore, inflation is well (more or less) on track and interest rates are reasonable. If this leverage occurs in an environment where the Federal Reserve is tightening monetary policy, or profits begin to slow, then I would be scared.
Nowadays I’m not scared, but I look at it out of the corner of my eye, because a little «yuyu» does give it. That it is true that the balance sheets are solidthat the bank it’s much better capitalizedthat the margin call They are not growing crazy. Yes. But I’m being more cautious.
The message is not to sell everything and hide in a warehouse. It is understanding that the Margin Debt it’s a risk appetite thermometer. When it rises a lot, it tells us that there is enthusiasm. And when it drops suddenly, it usually means fear. Both extremes can be opportunities… if one does not act motivated by emotions.
For the fund investor, this metric is one more piece of the puzzle. It does not replace valuation analysis, nor the quality of the assets in the portfolio. But it can help detect when the market is going too far. In those moments, rather than running with the herd, it is advisable to diversify, review the risk profile and avoid impulsive decisions.