Interview with Jesse Felder at The Felder Report on margin debt, corporate profits, and heightened risks to the stock market and US economy. Felder started his career in the late ‘90s at Bear Stearns before co-founding a multi-billion dollar hedge fund in Santa Monica, California. Subscribers can access the full podcast interview airing Wednesday by logging in and clicking here. Not a subscriber? Click here.
“Margin debt right now is suggesting returns over the next few years will be poor and because the rate of change is now negative, it's suggesting that we've already entered a bear market.”
What is margin debt and why is it important?
“Margin debt is the amount of borrowing, typically to buy financial securities, above and beyond the cash that's in an account. So if you have 00 in your account and you spend that all buying stocks and you want to buy another 00, your broker will lend you that much money so you could buy 00 worth of securities with only 00 of equity in your account.
…it's a very direct representation of potential supply and demand for stocks because stocks are typically what people lever up to buy. When there's very little borrowing being done there's a lot of potential demand out there to buy stocks since people can go borrow a bunch of money to buy stocks and push prices higher.
Conversely, when there's already a lot of borrowing being done—and we're close to levels where we've seen peaks in the past—that suggests to me that there's very little borrowing that can still be done; there's very little potential demand out there to push prices higher. And, in fact, all of that borrowing—like we've seen after the dot.com bust and during the financial crisis—a lot of times that borrowing becomes forced selling or supply in the market to potentially exacerbate a decline so it's one [indicator] that I watch pretty closely.”
Corporate profit margins have also peaked and appear to be falling. What’s the message here for investors?
“Over more than 80% of the time when corporate profits fall to the degree they have recently, we see a recession. So that's more than an 80% probability. But I think also...we recently saw record highs in profit margins for companies, which has been one of the things that's really been a boon to the stock market over the last seven years is that companies have been very, very profitable.
…this can be attributed to three main factors that are now potentially exhausted or reversing and the first is yields. Yields—or interest rates—have fallen and been falling for a long time, which makes debt a lot cheaper. And when you combine falling interest rates with very low corporate spreads it means debt has never been cheaper for companies...”