Margin debt refers to the money investors borrow to invest in stocks. When investors are optimistic about the stock market's short-term prospects, they tend to borrow more money to amplify their positions. Conversely, when they are pessimistic, they reduce their margin debt by repaying loans. As of October 31, 2023, the most recent data available, total US margin debt stood at $635 billion, marking a $35 billion decrease from the previous year.

Since margin debt often correlates with the size of the stock market, it is more insightful to view margin debt in relation to the total market value. Over the last 12 months, total margin debt has decreased by 0.08% of the entire US stock market's value. This change is 0.36 standard deviations below the historical average, which suggests that current market sentiment is Neutral regarding short-term returns.

This summary is illustrated in the chart below. For a more detailed analysis of the model and an explanation of how the chart was constructed, continue reading.

Theory & Data

Margin debt represents the money borrowed by investors to purchase stocks, with the debt typically secured by the stocks themselves. When margin debt increases, it amplifies the overall risk in the stock market. If the market declines, the value of the stocks used as collateral for the margin loans drops, leading to a "margin call." To meet the margin call, investors are forced to sell their stocks, which in turn drives the market even lower. This creates a positive feedback loop, meaning that higher margin debt can result in more significant market declines during a downturn.

Beyond the margin-call mechanism, monitoring margin debt levels serves as an indicator of market momentum. High margin debt suggests that investors are highly bullish, willing to borrow funds to invest further in stocks. Conversely, a decline in margin debt indicates that investors are less confident in the market's continued rise and are hesitant to borrow money for additional stock purchases.

Data cited in this analysis is sourced from FINRA and NYSE, with monthly updates on margin debt levels. The most recent data available is from October 31, 2023.

Total Margin Debt

The chart below shows the total margin debt in US accounts since 1970, adjusted for inflation to reflect present-day dollars. Initially, margin debt was rarely used, but it began rising exponentially in the mid-1990s, coinciding with the internet bubble. Following the crash, margin levels remained elevated, peaking again before the 2008 Great Financial Crisis (GFC). This trend repeated after the GFC crash, with margin debt now reaching the highest levels ever recorded.

However, it's important to note that the total value of the US stock market has also grown significantly over this time, even after adjusting for inflation. As the market's total size increased, it makes sense that the amount of borrowed money to invest in stocks would also rise. The chart below further examines total margin debt as a percentage of the total value of the US stock market, estimated using the Wilshire 5000 index.

Rather than simply looking at the level of overall margin debt, we aim to assess how quickly margin is changing over time. This allows us to gauge investor confidence: Are they borrowing more to increase their long positions, or is the appetite for risk diminishing? To capture this, we examine the rolling year-over-year change in total margin debt, focusing on how much margin debt has changed in the prior twelve months.

The chart above shows that margin debt has grown significantly in recent decades. As a percentage of the total value of the stock market, margin debt has risen since 1970, but its increase has slowed since 2000. However, when we look at the change in margin debt relative to the size of the stock market, the swings appear to be more contained. Margin debt typically fluctuates within a small single-digit percentage of the stock market's value, with substantial changes occurring when the total margin debt increases or decreases by around 2% of the market's total value over twelve months.

The key question is how margin debt levels might influence overall market valuation. Following significant increases in margin debt, the market is more likely to underperform. This is because the selling pressure caused by deleveraging (investors being forced to reduce their margin positions) can accelerate a market correction or crash. The chart below revisits the year-over-year changes in margin debt, with highlights indicating periods when 1-year stock market returns have been negative. Notably, nearly every peak in margin debt is followed by a period of negative stock market returns as the margin debt unwinds.

To analyze margin debt levels in context, we typically use a ranking system based on how many standard deviations the values are from the mean. This model helps quantify the deviation of margin debt from historical norms, offering insights into current market dynamics. The following chart is similar to the one shown earlier, but now includes horizontal bands that represent the number of standard deviations from the mean, giving a clearer view of the extent to which margin debt is outside of its typical range.