What Me Worry? Margin Debt Remains High Even as Market Slumps

Election angst and concerns about tech earnings growth and are assigned much of the blame for the market's recent malaise. But another insidious factor appears to be at work: investors' margin debt. October's New York Stock Exchange margin level, released this morning, came in at $233 billion, lower than September's $251 billion. But margin debt remains high by any measure.

NYSE Margin Debt (in Billions)

Source: NYSE

Nasdaq Margin Debt (in Billions)

Source: Nasdaq

Data from the NYSE and the Nasdaq show that investors have taken on an unprecedented amount of margin debt to finance their stock purchases over the past year. That hefty helping of debt started growing in November 1999 as stock market indices were making their historic runs to all-time highs. Along with the markets, margin debt peaked in March.

Nasdaq Performance

S&P 500 Performance

That makes sense, as margin debt can help propel stock prices higher. But in a down market, margin debt can also accelerate the decline.

Here's how it works. Buying on margin means borrowing money against your account to buy stocks. You might, for example, have $10,000 in cash but buy $15,000 worth of stock, using $5,000 of borrowed money from your broker. When stock prices are soaring, investors who borrow against their accounts look like geniuses. But when the market begins to head south, investors who borrowed money to finance stock purchases may be subject to margin calls: Brokers demand that investors add money to their accounts so the collateral is sufficient to cover the erosion in portfolio value.

If an investor is unable to meet that margin call with new capital, the broker may sell some or all of the investor's remaining stock. In doing so, the broker can contribute to the market's decline.

And that is probably one of the factors at work these past six weeks. With September margin levels approaching the highs set in March, many investors were likely forced to capitulate to the market's magnetic negative pull. And the drop in October's margin debt level supports that conclusion.

Still, even with October's drop in margin debt, Bill Meehan, chief market strategist at Cantor Fitzgerald, says there is not enough fear in the market, which is "indicated by high margin debt levels."

We are "absolutely, positively not near a bottom and therefore margin remains a problem facing the market," he says.

Charles Biderman, CEO at Trimtabs.com, a firm that tracks stock-market liquidity, said Monday that a fall in the NYSE margin debt level would not be surprising in light of margin calls that probably occurred in October.

If Meehan is right, and you're still heavily margined, you'd probably do well to reduce your margin debt on your own, instead of having the margin man come in and do it for you. Just ask the folks who were part of that margin debt reduction in October.