This article was originally written by Doug Short. From 2016-2022, it was improved upon and updated by Jill Mislinski. Starting in January 2023, AP Charts pages will be maintained by Jennifer Nash at Advisor Perspectives/VettaFi.
Margin debt is the amount of money an investor borrows from their broker via a margin account. Trading with a margin debt can magnify gains because an investor can benefit from the upside of any stock without having to invest 100%, resulting in greater profit. With that being said, trading with margin debt can also exacerbate losses because if a stock's value were to depreciate, the investor may face a margin call and would need to come up with additional cash to reach the minimum requirement.
The Latest Margin Data
FINRA has released new data for margin debt, now available through February. The latest debt level is at 624.38 billion, down 2.6% month-over-month (MoM) and down 25.3% year-over-year (YoY). However after adjusting for inflation, debt level is down 3.2% MoM and down 29.5% YoY. Let's examine the numbers and study the relationship between margin debt and the market, using the S&P 500 as the surrogate for the latter.
The first chart shows the two series in real terms — adjusted for inflation to today's dollar using the consumer price index (CPI) as the deflator. At the 1997 start date, we were well into the boomer bull market that began in 1982 and approaching the start of the tech bubble that shaped investor sentiment during the second half of the decade. The astonishing surge in leverage in late 1999 peaked in March 2000, the same month that the S&P 500 hit an interim daily high, although the highest monthly close for that year was five months later in August. A similar surge began in 2006, peaking in July 2007, three months before the market peak. Debt hit a trough in February 2009, the same month the market hit a bottom. It then began another major cycle of increases. Most recently, we saw a similar surge after the COVID-pandemic, peaking in October 2021, two months before the market's all-time high.
Note on the data: The FINRA only posts the free credit cash accounts data back to 1997. The free credit cash accounts data back to 1980 is available on a fee basis from Haver Analytics.
At the suggestion of Mark Schofield, managing director at Strategic Value Capital Management, LLC, I've created the same chart with margin debt inverted so that we see the relationship between the two as a divergence.
The next chart shows the percentage growth of the two data series from the same 1997 starting date, again based on real (inflation-adjusted) data. I've added markers to show the precise monthly values. Margin debt grew at a rate comparable to the market from 1997 to late summer of 2000 before soaring into the stratosphere. The two synchronized in their rate of contraction in early 2001. But with recovery after the tech crash, margin debt gradually returned to a growth rate closer to its former self in the second half of the 1990s rather than the more restrained real growth of the S&P 500. But by September of 2006, margin debt again went ballistic. It finally peaked in the summer of 2007, about three months before the market. Debt continues to peak as does the market soon after. Most recent evidence of this was in 2021 when the margin debt peaked in October and the market followed two months later by peaking in December.
NYSE Investor Credit
Lance Roberts of Real Investment Advice analyzes margin debt in the larger context that includes free cash accounts and credit balances in margin accounts. Essentially, he calculates the credit balance as the sum of free credit cash accounts and credit balances in margin accounts minus margin debt. The chart below illustrates the mathematics of Credit Balance with an overlay of the S&P 500. Note that the chart below is based on nominal data, not adjusted for inflation. Here, we have retained the NYSE data through November 2017 and switched to the FINRA data. (see note at end of article)
Here's a slightly closer look at the data, starting with 1997. Also, I've inverted the investor credit monthly data and used markers to pinpoint key turning points.
As I pointed out above, margin debt data is several weeks old when it is published. Thus, even though it may, in theory, be a leading indicator, a major shift in margin debt isn't immediately evident. Nevertheless, we see that the troughs in the monthly net credit balance preceded peaks in the monthly S&P 500 closes by six months in 2000 and four months in 2007.
We are past the longest bull market in history. The peak in margin debt preceded the peak in the monthly S&P closes (the December 2019 peak) by 23 months, much longer than the previous shifts prior to corrections. Interestingly, the most recent peak (Dec 2021) was not preceded by a trough, unless we use the February 2009 point as a reference!
There are too few peak-trough episodes in this overlay series to take the latest credit balance data as a leading indicator of a major selloff in U.S. equities. This has been an interesting indicator to watch and will certainly continue to bear close watching in the future.
Note: The NYSE suspended its NYSE member firm margin data as of December 2017. I have replaced our margin debt data with FINRA data, which includes data for all firms, not just NYSE member firms.
The New York Stock Exchange previously published end-of-month data for margin debt on the NYX data website, including historical data going back to 1959. Because of NYSE's suspension of publication, we have turned to FINRA to continue our analysis. The figures differ in their inclusion of firms. For data through January 2010, debit balances were derived by adding NYSE debit balances in margin accounts to FINRA debit balances in customers' cash and margin accounts and credit balances were derived by adding NYSE free credit balances in cash and margin accounts to FINRA free and other credit balances in customers' securities accounts. For data after January 2010, "As of February 2010, data are collected pursuant to FINRA Rule 4521 and are aggregated across all member firms, regardless of whether the firm was designated to NASD or the New York Stock Exchange (NYSE) before the consolidation of NASD and the member firm regulation operations of NYSE Regulation in July 2007 that created FINRA," (FINRA statistics definition, FINRA website). As a result of this change, the debt data is higher than the NYSE data.