That margin debt kept rising into the last month of last year is no surprise: after all, with a market that was destined to follow the Fed’s balance sheet through thick and thin, there was “no risk” – just remember what David Tepper said: no taper is bullish, a taper is even more bullish as it means the economy is recovering and 20x P/E multiples are just around the corner. Sure enough as reported earlier by the NYSE, margin debt rose by another $21 billion in December to an all time high of $445 billion, and up 29% from a year ago – incidentally almost identical to the increase in the S&P.
This much should come as no surprise to anyone.
However what may come as a shock to many is that the other key metric provided by the NYSE – total net free credit – also known as investor net worth (calculated as Free Credit Cash plus Credit Balances in Margin Accounts less Margin Debt) just dropped to a whopping $148 billion, double where it was in February 2013, and double where it was during the peak of the last stock (and credit and housing) bubble, when it rose to a then-all time high of $79 billion in June 2007. It was all downhill from there.
Of course, this is elementary margin debt as reflected by the simplest of analysis using NYSE data – something that in a world of near-infinite rehypothecation is irrelevant. To get a sense of what is really going on out there, we repost from an article we did in November of last year when we showed the ridiculous levels leverage has reached with the “ultra-sophisticated” hedge fund investor class (where apparently the one with the highest beta leverage, wins) in this case Balyasny Asset Management.
Behold a chart that needs no explanation:
During our soft-close period over the last two years, we have doubled the size of our allocations and our balance sheet while keeping AUM roughly the same. Our plan is to accept only enough new capital to allow us to keep our assets / notional dollars allocated ratio at 1 to 5.
We find that portfolio managers on average utilize about 70-80% of their maximum allocations – so $1 of assets to $5 in notional allocated dollars typically results in our target gross leverage of 3.5-4x. We will be very disciplined with this so please let us know as early as possible if you are interested in increasing your allocation next year.
Of course, when one is levered nearly 5x, being “very disciplined” is usually a good idea.
So a pop quiz: if a hedge fund is levered 5x, and there is a 20% drop in the market, what happens?
For some more thoughts on margin debt, here is Deutsche Bank who Hopes “Not All Margin Calls Come At Once In Case Of A Sell-Off“