Margin Debt at Record High, Up 13.2% in Nov.

The amount of money Americans have borrowed to buy stocks on “margin” jumped 13.2% in November, representing the largest monthly increase in such debt since December 1971--and fanning more concern that the market is nearing a speculative peak.

“The high level of margin debt is a growing danger, and a danger that few people are paying attention to,” said Alan Skrainka, market strategist for St. Louis-based brokerage Edward Jones. If the market should suddenly tumble, investors buying stocks on credit could suffer massive losses.

By almost every measure, total margin debt is now at historic levels. According to the New York Stock Exchange, total outstanding margin debt among customers of its member brokerages jumped $24 billion for the month to a record $206.3 billion. That corresponds to the dramatic rise in technology stocks in November.

As a percentage of the gross domestic product, margin debt is at its highest level since 1959 (around 2.2%). And relative to the total market capitalization of NYSE-listed stocks, margin debt is at its highest since 1945 (about 1.8%), according to Ned Davis Research, based in Venice, Fla.

“When we see this [kind of] evidence of excessive bullish sentiment, speculation or people getting too excited, it’s usually a precursor to a market downturn,” said Sam Burns, an analyst for Ned Davis.

Margin debt reflects brokerage loans that are typically secured against the value of an investor’s account. Under rules set by the Federal Reserve, investors can buy up to $2 worth of stock for every $1 in cash held in their account.

The benefit of this form of “leverage” in a rising market is clear:

Let’s say you buy $10,000 worth of Microsoft stock, using $5,000 in cash and $5,000 in margin. If the value of the stock rises to $15,000, the shares would have appreciated 50%. However, since you used only $5,000 of your own money to purchase it, your personal gain would be 100%, less the interest cost of the loan.

When the markets fall, however, margin debt works against investors for similar reasons.

And in the event of a market slide, a margin investor’s tumbling portfolio can trigger a “margin call.” In other words, the investor’s broker may require the investor to deposit additional cash or securities to offset the drop in the account’s value. If that deposit isn’t made, the firm may sell the stock bought on margin to recoup its loan.

This is what happened to many margin investors in August 1998, when the global financial crisis shook world markets as margin debt levels were rising sharply. “People got margin calls and had to pull back some of this debt as the markets were falling,” Burns said. “This is why you tend to get sharper drops when margin debt levels are high--it just feeds on itself.”

But record margin debt levels “may not necessarily be such a negative thing,” said Peter Canelo, U.S. investment strategist at Morgan Stanley Dean Witter & Co.

While margin debt levels have risen, so too has the wealth of investors throughout the ‘90s bull market. “If you were to make some adjustments not for GDP but for the wealth of people in the market, it might be less scary,” Canelo said.

“The question is, where is this money going? If all this money is being used to buy utility stocks, you might not be worried. But if it’s all in [more volatile] Internet stocks, then that’s a different story.”

Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.

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Stocks on Credit

Investors’ use of debt, or margin, to buy stocks soared in November. Quarterly totals and Nov. 30 total for margin debt outstanding among clients of New York Stock Exchange-member brokerages, in billions:

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Nov. 30, 1999: $206.3 billion

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Source: New York Stock Exchange