While the use of margin has been regulated by the Securities & Exchange Commission since the mid-1930s, the use of it during the DotCom Bubble and the run up to the 2007 stock market highs, showed significant increases in its use testifying how euphoric investors became as the market rallied to new highs.
While many experienced market veterans wait until a bear (down) market decline shows signs of bottoming before they use borrowed money to invest in stocks, many uninitiated investors use borrowed money after the dramatic advance in price has occurred.
To review, investors who purchase stocks on margin borrow part of the purchase price of the stock from their brokerage firms. The brokerage firms in turn borrow money from banks at what is known as the “call money rate” to finance these purchases and charge their clients that rate plus a service charge for the loan.
All securities purchased on margin must be left with the brokerage firm in what is known as “street name,” because the securities are used as collateral for the loan.
For years this column has focused on the theme that as the market experiences long-term declines or advances, general investors become conservative or less conservative respectively. Margin figures at major market tops illustrate how gutsy investors get after a period of long-term rising prices with very short-term declines along the way. In general, investors become less conservative as the market moves higher and more conservative as it moves lower.
Funny thing isn’t it, as stock prices advance and become historically over-valued, investor psychology becomes complacent and aggressive. Conversely, as stock prices decline and become historically undervalued, that same psychology becomes anxious and conservative. Just the exact opposite as it should. In fact, if one were to “bet the farm” and load up on stock with margin, the smart thing would be to do it after a long-term bear market, not vice-versa.
Quote of the week: “Statements by high officials are practically always misleading when they are designed to bolster a falling market.” — Gerald M. Loeb