22 August 2019

Appetite For Risky Margin Loans

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Nick Restaino is bullish on stocks again after January’s dramatic rebound and is using money borrowed against his investments to buy shares of popular technology companies such as Nvidia Corp. and Roku Inc.  

The 22-year-old student in Doylestown, Pa., bought shares of those stocks in recent weeks and reversed short bets he made in December. He did it with cash on hand and about $15,000 in borrowed money, roughly doubling his buying power.  

“A lot of stocks that dipped...are starting to regain some of their value,” said Mr. Restaino, adding that he plans to buy more shares using additional margin debt. “This is an opportunity to take advantage of the large amount of margin I have.”  

Mr. Restaino isn’t alone. In the fourth quarter, investors trimmed the amount of margin debt they used to buy stocks at the fastest pace since the financial crisis. But some Wall Street and brokerage executives say those loan levels stabilized or moved higher last month as the S&P 500 rebounded, posting its best January performance since 1987.  

Margin debt, which is generally considered a gauge of investor confidence, tumbled more than $90 billion in the fourth quarter to $554.3 billion, the lowest tally since December 2017, according to the Financial Industry Regulatory Authority.  

Although the pace of the decline was jarring, analysts at Bank of America Merrill Lynch and other firms say the pullback supports the case that the stock market has bottomed and is poised for a rebound—albeit with ongoing spikes in volatility—similar to other recoveries following drawdowns in February 2016 and September 2011.  

“We’ve seen the [margin debt] numbers come back a bit as the S&P 500 has rallied into 2019,” said JJ Kinahan, chief market strategist at brokerage firm TD Ameritrade HoldingCorp. , adding that fluctuations in margin debt tend to be highly correlated with the broad index. “As the S&P 500 drops, you’ll see margin levels drop. As it comes back, it recovers in a similar way.”  

Investors tend to be more willing to take loans against investments that are rising in value, but such debt can amplify gains and losses, leaving investors vulnerable in a market pullback such as the one in the fourth quarter.  

Mr. Restaino, for example, says he has access to $50,000 in available margin debt, including what he has invested so far, pledged against roughly $20,000 in equity. But if the value of his collateral shrinks enough, brokers can demand repayment. If the margin call isn’t met, the securities backing the loan are sold and he would responsible for any remaining balance.  

At TD Ameritrade., December’s decline in margin balances was the most pronounced since the collapse of Lehman Brothers Holdings Inc. in 2008, said Tim Hockey, the firm’s chief executive. “That trend is reversing because people are net buyers” now, he said.  

Rival brokerage E*Trade Financial Corp. also says margin debt has stabilized, with balances in January expected to be near December’s $9.6 billion sum. “It’s really the indicator or the lead indicator of investor confidence in the marketplace,” E*Trade CEO Karl Roessner told analysts on a conference call last month. “That balance on our side has been up a little bit.”  

An increase in margin debt would help rejuvenate a bull market that had been on the brink of collapse in December by adding more buying power, analysts say. The S&P 500 remains down 7% from its September record but has rebounded 16% from its Christmas Eve low. Renewed faith in the U.S. economy and comments from Federal Reserve Chairman Jerome Powellsignaling a pause in the central bank’s campaign of interest-rate increases have eased investors’ fears of an imminent recession. Sentiment has been further stoked by strong corporate profits and attractive valuations.  

But most Wall Street analysts say the stock market remains vulnerable to many of the same risks it faced last year, leaving major indexes susceptible to another pullback that could trigger another drawdown in margin-debt balances.  

Trade tensions between the U.S. and China that rocked stocks last year remain unresolved, even though President Trump gave an upbeat assessment of a recent meeting between leaders of the two countries. And companies from Ford MotorCo. to Caterpillar Inc. to 3M Co. have offered weaker-than-expected outlooks for the year, which could further hamper an already slowing U.S. economy.  

Margin balances peaked in May 2018, hitting a record $668.9 billion, according to Finra data. But hawkish comments from Mr. Powell last year about the pace of potential interest-rate increases and worsening relations between the U.S. and China on trade policy contributed to a five-month decline in margin debt that pushed balances down 17% through December.  

Still, margin debt remains at elevated levels after the long-running market rally, said Devin Ryan, a brokerage analyst at JMP Securities, who also said he expects balances to register a tick higher in January. Margin debt across Wall Street accounted for about 1% of the S&P 500’s total market value in December, down from a peak of 1.4% in July. That is still well above a monthly average of 0.2% in Goldman Sachs data going back to 1997.  

Previous pullbacks have been more devastating on margin-debt balances, according to Goldman’s data. In the wake of the dot-com bubble in 2000 and the 2008 financial crisis, net margin debt stood as low as minus-0.6% and minus-1.8%, respectively, relative to the S&P 500’s market cap.   

After such an abrupt decline in margin debt at the end of 2018, investors “may be a little more timid” when it comes to taking on more risk, Mr. Ryan said. But given the tendency for investors to increase leverage as markets rise, he said he expects margin balances to expand back to historic highs.  

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