Newspaper article International Herald Tribune

Speculation Crosses into Danger Zone

Newspaper article International Herald Tribune

Speculation Crosses into Danger Zone

Article excerpt

The pattern indicates that the stock market rally that has carried the S.&P. 500 to record levels will not last much longer.

American investors have taken out more margin loans than ever before. That indicates that speculative investing has grown among retail investors, reaching levels that in the past indicated the market was getting to unsustainable levels and might be in for a fall.

The amount owed on loans secured by investments rose to $384 billion at the end of April, according to data compiled by the Financial Industry Regulatory Authority, or Finra. It was the first time the total surpassed the 2007 peak of $381 billion, a peak that was followed by the recession and credit crisis.

The accompanying charts show the level of outstanding margin debt since 1960, both in dollars and as a percentage of gross domestic product. The latest total of borrowing amounts to about 2.4 percent of G.D.P., a level that in the past was a danger signal.

Rising margin debt was once seen as a primary indicator of financial speculation, and the Federal Reserve controlled the amount that could be borrowed by each investor as a way to dampen excess enthusiasm when markets grew frothy. But the last time the Fed adjusted the margin rules was in 1974, when it reduced the down payment required for stocks to 50 percent of the purchase price, from 65 percent. That came during a severe bear market.

Since then, the Fed has been on the sidelines. The view there, and among professional investors, has been that far greater leverage is available through options and futures, not to mention more exotic derivatives, so changing the rule would have little effect on levels of speculation.

Nonetheless, margin loans have remained popular with many individual investors, who tend to raise their borrowings during times of market optimism and to reduce them when markets are falling. …

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