Margin Debt Grows; Caution Still Rules Stocks
The stock market is so attractive to some individual investors, they’re borrowing money to get in.
The use of margin debt to buy stocks and other investments has been rising sharply in recent months, some brokerages report.
At Charles Schwab & Co., the nation’s largest discount brokerage, margin borrowings recently surpassed the previous peak of $1.3 billion set in the summer of 1987--just before the market crash.
Another major national discount firm, Quick & Reilly, says margin borrowing now is up 80% from levels of January, 1991.
Bearish market analysts may be tempted to seize on this margin activity as a sure sign that stock speculation is rampant, and that a peak in prices is near. But compared to the overall jump in stock purchases by individuals over the past year--plus the continuing rise in their “cash” assets, such as money market accounts--margin borrowing remains low:
* At Schwab, the previous margin debt peak of $1.3 billion in 1987 amounted to 7.6% of the $17 billion in assets that Schwab clients had with the firm then.
* Today, though Schwab’s margin debt has rocketed to $1.41 billion from $900 million at the end of 1990, Schwab clients have $50 billion in assets with the firm. So that $1.41 billion in margin amounts to just 2.8% of assets.
What’s more, one-third of Schwab’s client assets are sitting in cash accounts, says Mark Thompson, a vice president at the firm in San Francisco. That suggests many individual investors remain extraordinarily cautious about the stock market. Otherwise, more of that cash would be flooding into stocks.
The bottom line: Rather than a signal of a market peak, the rising use of margin may be a sign that this bull market has a lot further to run. Given the assets of Schwab’s customers, for example, their ability to use margin far exceeds what they’ve borrowed so far. “There’s still a quite significant amount of cash and cash equivalents available to go into the market,” Thompson notes.
Those investors who are using margin debt are merely responding to extraordinarily low short-term interest rates. In fact, some of the money being borrowed may be going toward uses other than investment purchases--to consolidate other loans held by an investor, perhaps.
Schwab, for example, charges annual interest of 6.5% to 7.5% on margin debt, depending on the size of the account. Other brokers may charge even less.
In contrast, short-term loan rates at many banks remain in double-digit territory. So margin borrowing has become one of the cheapest sources of short-term money for many investors. Generally, investors can use margin loans to borrow up to 50% of the value of their investments.
Margin borrowing can be very dangerous, though. If short-term interest rates begin to rise, so too will margin loan rates. And if you buy stocks with 50% on margin, you will lose your capital twice as fast if the market goes down. To illustrate:
* Say you have $50,000 cash and invest that in stocks. The market suddenly drops 20%. You’ve lost $10,000 of your $50,000 capital, leaving you with $40,000.
* Now say you had used your $50,000 in capital to margin another $50,000 and buy $100,000 worth of stocks. The market drops 20%. Your portfolio is worth $80,000. But you owe the brokerage $50,000 for the loan, so your own capital now is just $30,000.
Of course, if the market rises, the leverage works the other way--you double your potential winnings by using margin. But the downside shows why margin use in buying stocks is only for investors who can afford to take big risks.
What Now for Bonds?Yields on Treasury bonds jumped again last week, coinciding with the Treasury’s big once-a-quarter auction of new bonds. The yield on 30-year T-bonds finished the week at 7.91%, up from 7.76% a week earlier and 7.39% at year’s end.
Bonds continue to suffer because the supply of new bonds is temporarily exceeding demand from investors. Thus, yields have to rise to entice more buyers out of the woodwork.
Robert Barbera, an economist at Shearson Lehman Bros., says one key problem for bonds is that some bond investors suddenly are switching to stocks. Why? For one, investors who owned bonds during all of last year made a tidy profit, as market interest rates dropped, making older bonds worth more.
The typical bond mutual fund that owns long-term Treasury bonds, for example, rose about 7.2% in value last year, in addition to yielding about the same amount in interest, according to fund-tracker Lipper Analytical Services.
Now some bond investors see stocks as the better alternative, assuming that the economy recovers this year (and with it corporate profits). So these opportunists are selling bonds to buy stocks, Barbera says.
Though many new investors still are buying bonds, when others began to leave the market in January the net effect was to push yields up.
The exodus from bonds shows up in net cash flow figures from bond mutual fund managers such as Benham Capital Management in Mountain View, Calif.:
* In December, Benham’s fund that invests in Government National Mortgage Assn. bonds, a popular bond instrument, had a net inflow of $37 million.
But in January, the fund suffered a net outflow of $15 million as more investors sold out than bought in.
* Likewise, Benham’s Treasury Note fund, which had a net inflow of $20 million in December, lost a net $4.5 million in January.
At some point, however, selling by bond profit takers will run its course, and that will relieve much of the upward pressure on yields. Most investors, after all, buy bonds for income, not for capital gains, and yields have just gotten more attractive with this latest rise.
How soon might the profit taking end? Benham’s investors, at least, seem to offer hope that the selling is winding down. So far this month, Benham says its GNMA fund has seen a net inflow of $3.5 million, and the Treasury Note fund is up $3.8 million.
It’s not much, but it’s a start.
Briefly: California State Treasurer Kathleen Brown says she’ll proceed with plans to sell $1.4 billion in new California general obligation bonds on Wednesday, despite the recent rise in market interest rates, and despite Friday’s downgrading of the state’s credit-worthiness by bond-rating firm Fitch Investors Service.
Fitch cut the state’s rating to AA-plus from AAA, citing state budget woes. That followed a similar downgrading by Moody’s Investors Service earlier last week. A lower credit rating means that the state pays a higher yield on its bonds--good for investors, bad for the state. . . .
Newport Beach-based brokerage Cruttenden & Co. holds its annual Southern California Growth Stock conference at the Le Meridien Hotel in Newport Beach on Wednesday and Thursday. A total of 50 Southland companies will pitch their stories to investors. Firms scheduled to attend include retailer Smart & Final, biotech firm Gensia Pharmaceuticals and athletic shoe maker Vans Inc. . . .
Short sellers, who profit when stock prices drop, continued to be hammered in January. Centurion Trust of San Diego, which tracks returns of 18 investment firms that specialize in short selling, says the average firm lost 7% of its portfolio in January. Though blue chip stocks fell in the month, many of the smaller stocks that short sellers have targeted continued to rise, Centurion notes.
Borrowing to Buy Stocks
Investors have shown a much greater willingness to buy stocks and other securities on margin--that is, using borrowed money--as this bull market has progressed. Here’s how such debt soared since 1989 at the nations largest discount brokerage, Charles Schwab & Co.:
Source: Charles Schwab & Co.
