The stock market’s mood can change on the dime. And when things get really out of whack, it’s up to the prudent advisor to notice it before it whacks client portfolios.
Case in point: Excessive leverage in the equity market. Margin debt on the NYSE rose for six consecutive months and hit a record high of $444.93 billion in Dec. 2013. Margin debt represents the amount of money owed by customers to their broker for borrowing money to purchase securities. After posting five consecutive yearly gains, the memory of stock market losses is old.
Instead of being a sign of investor confidence, record margin debt always points to trouble ahead. Over the past 15 years, we’ve seen this pattern of boom and bust consistently repeat itself with the 2000-02 dot-com crash, the 2007-09 housing crash and the 2008-09 financial crisis.
Almost every major market top, and subsequent correction or crash, is associated with excessive leverage (or borrowing) and excessive risk taking. Never before in history has a voracious borrowing binge by investors or speculators with margin debt ever had a happy ending. Will this time be different?