Grandma to Wendy: never use margin

Investment Analysis Clubs Macro Economic Trends and Risks
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Grandma and Grandpa (Dad’s parents) owned the house my family grew up in. They lived in the upstairs apartment of the large 2-family house. I was very close with Grandma who spent many hours telling stories about investing in the 1920s, the Great Depression and the post-WW2 boom. Her nickname for me was “My Little Dividend” when she introduced me to her friends. :slight_smile:

Grandma warned me to never use margin after witnessing the devastating effects of margin in the 1929 crash. She was a successful, active investor in stocks and bonds but did not take the risk of leverage.

Broad market leverage can magnify a stock market downturn into a crash as investors sell good assets to meet margin calls.

https://www.wsj.com/finance/investors-borrowed-like-crazy-during-the-rally-now-theyre-paying-the-price-608115e7?mod=hp_lead_pos1

Investors Borrowed Like Crazy During the Rally. Now They’re Paying the Price.

Behind the market tumult of the past month: the rapid unwind of several popular trades and the heavy use of leverage

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Gregory Zuckerman, Jack Pitcher, Vicky Ge Huang and David Uberti, The Wall Street Journal, Updated Aug. 12, 2024

They built over months: big bets on the Japanese yen. Complex cryptocurrency wagers. Investments in hot tech companies.

Common to all the trades were heavy doses of leverage, or borrowed money, which investors used to amplify expected gains. As markets rose through the first half of 2024, the investments generated windfall profits, inspiring copycat traders to get on board and pushing prices higher.

Now the tide has turned. Unrest has returned to global markets over the past month, and investors are now in retreat from these once-unstoppable trades…

How much leverage had investors piled up? In July, net bets against the yen by hedge funds and other speculators that usually rely on leverage reached their highest levels since 2017, according to the Commodity Futures Trading Commission. The net figures reflect short positions, betting on declines, minus long positions, anticipating gains. …

Pros are bracing for more volatility. They are circling the August employment report, set for release on Sept. 6, on their calendars. A second straight disappointment could confirm the worst fears of economic skeptics, sparking a new round of deleveraging. A strong report could show that July’s report was a one-off slowdown, affected by hurricanes…[end quote]

Statistics from FINRA show that margin is high and growing. Since borrowed money increases demand, margin borrowing correlates with stock prices.

Speculative trades, such as the yen carry trade, cryptocurrency and tech stocks, can reverse rapidly. When magnified by margin they can carry the whole market down.
Wendy

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That is true of leverage in any context. We talked about this in my finance classes in the 70s. But now, it’s the Shiny thing to leverage a company out of it’s skull, like Boeing, with it’s Billions in negative equity. The only thing keeping it afloat is an expectation it will continue to pay it’s bills, in the face of repeated Billion dollar losses.

Steve

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Most investors, are not sophisticated to do a trade like yen-carry trade. While the lesson of leverage is important, but when you buy a house you take 4x leverage and compared to that the margin people take are far less. Of course the price of house is generally very stable compared to stock market.

Rather than saying don’t use leverage or margin, know what you are doing is more important. You don’t have to use leverage to lose money, you could do that on REIT’s and then blame the management. :slight_smile:

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I agree that margin purchases are risky and not for the average investor.

However, having a margin account has some advantages. If funds are not available when a bill comes due, broker loans you the funds (for interest fees) rather than rejecting the payment request.

OK, when used responsibly (as with many investment choices).

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Adding some color, Yen carry trade is going on for more than 10 yeas, i.e., from 2014. Compared to historical margin debt level, current margin debt is not high. See below graph, you will see we are below the trend line.

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Contrary to many market commentators, Yen-carry trade is very big in currency market. That is borrow in yen and invest in Mexican Peso (short-term rate is 10~ 11%?) or other currencies.

This gem is for @ptheland. Who are the biggest players in yen-carry trade??? Insurance companies!!! Yeap, the well regulated folks.

Often the reason you see immediate sale in tech is not necessarily because the yen-carry is done with tech stocks, rather when you got margin call, tech is the very liquid security that can be sold quickly. No one is confirming but last Monday morning some “margin call” induced sale had occurred.

The reason I am posting this is not to minimize the dangers of margin trade rather the common wisdom often misses a lot of details.

Separately, you cannot avoid these things, even if you don’t participate there are others whose action may directly or indirectly impact you. Keep some liquidity and try to have a bit longer-term view.

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I’ve always been careful with leverage in the real estate market having witnessed Houston’s real estate collapse in the mid-1980’s. It was a wonder seeing colleagues with fine homes in nice neighborhoods bringing $30,000 to $40,000 checks to the closing as the SELLER. That’s when I started using the rent vs. buy analysis to inform my housing decisions. Since the average home in the US appreciates at 4% per year (and about half of them at less than 4%) while the S&P 500 delivers 10%+ over the long run, you can usually do better renting and putting your 20% down payment in the stock market.

The rent vs. buy analysis didn’t turn positive for me until 2012 when I was living in a Portland OR suburb and I paid cash for a home at 70%-off its 2008 value. It’s since nearly quadrupled in price. And how did I pay cash for a home? The difference between 10% and 4% (or less) compounded over 2 or 3 decades is a fortune.

intercst

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I think the cycle could be summarized thusly…

  • it can’t happen
  • it can’t POSSIBLY happen
  • it can’t happen to ME
  • it can’t happen AGAIN
  • it can’t POSSIBLY happen AGAIN
  • it can’t POSSIBLY happen AGAIN to ME

I have concluded that the vast majority of humans are not only inherently incapable of understanding random phenomena and statistics, they are WORSE at understanding the meaning of probabilities of repeat events. It’s as if they believe if they already suffered one loss or near-miss, that was their brush with negative outcomes and they have some cosmological hyperspace button they can press to escape any future similar bad outcome. This makes them MORE likely to take risks after escaping them the first time.

WTH

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