Month: December 2018

As Deutsche Bank’s Craig Nicol writes, it might not have felt like it given some of the big swings for assets intra-month, but compared to October, returns for assets during November were fairly tame by comparison. Indeed the overall picture was mixed in the end with 15 of the assets tracked by the German bank’s sample finishing with a positive total return in USD terms (out of 38) and 17 in local currency terms. That said, the YTD picture still remains fairly bleak with only 10 assets currently positing a positive total return in local currency terms, and just 5 assets in USD terms.

For the month of November specifically, concerns around many of the same issues which plagued markets during the year – namely Italy, the trade war and Brexit – remained a factor however a historic plunge in the price of Oil (just as Goldman was telling its clients to buy), which saw WTI (-22.0%) and Brent (-20.8%) easily finish bottom of the pack, added to the list. This was the worst month for WTI since October 2008 and the second worst month based on data back to the start of 2001.

Despite that risk assets were actually fairly resilient although the monthly return does hide sharper intra-month moves as noted earlier. For equities, Asia led the way with the Hang Seng (+6.2%) and Nikkei (+2.0%) two of the top performing markets in local currency terms. EM equities also returned a solid +4.1% while in the US the S&P 500 finished with a +2.0% return. The NASDAQ (+0.5%) did however underperform as tech stocks continue to lag. The picture in Europe was a lot more mixed with the STOXX 600 (-0.3%) and DAX (-1.7%) slightly down while the IBEX (+2.3%) and FTSE MIB (+0.9%) finished in positive territory – the latter seemingly supported by signs that the government might be softening its budget stance. It wasn’t all rosy for peripheral markets however with equity markets in Greece (-1.5%) and Portugal (-3.1%) lower.

For credit, November will likely be remembered as the month that spreads really started to leak wider as a combination of idiosyncratic issues and a catch up to broader market volatility weighed on the asset class. Europe once again underperformed the US with EUR HY and IG Non-Fin returning -2.0% and -0.6% respectively. US HY returned -0.5% and while that was a slight outperformance compared to Europe, HY did underperform US IG (-0.1%) and Senior (0.0%) and Sub (-0.4%) financials which in turn has trimmed some of the YTD outperformance.

For sovereign bond markets, with the exception of Gilts which returned -1.3% as concerns about the current Brexit deal passing UK Parliament weighed, Deutsche Bank notes that returns were solid but unspectacular and were helped by a more dovish Fed towards the end of the month. That helped EM bonds lead the way with a +3.2% return while BTPs returned +1.6% and Treasuries +0.9%. Bunds (+0.4%) also posted a small positive return.

As for the picture YTD, the drop for Oil in November has seen Brent (-5.6%) and WTI (-15.7%) now turn negative for the year, having held two of the top four places in DB’s leaderboard at the end of October. They’ve now been replaced by the MICEX (+19.6%) and Bovespa (+17.1%) – i.e. Russia and Brazil – in local currency terms, where the weaker respective currencies have certainly helped, given the much more modest +2.8% and +0.3% USD returns for the two markets. The NASDAQ (+7.3%) and S&P 500 (+5.1%) are two other markets to continue to hold positive total returns this year along with Bunds (+2.4%) and Spanish Bonds (+2.7%) – however USD returns are -3.5% and -3.1% respectively – while US HY continues to cling on with a +0.7% gain for the year. In contrast, European Banks (-19.0%), the Shanghai Comp (-19.8%) and Greek Athex (-20.2%) continue to languish at the bottom of our leaderboard. The broader STOXX 600 is now -5.1% and -10.5% in local and USD currency terms. With the exception of HY, US credit is down -0.5% to -1.8% while EUR credit is anywhere from +0.4% to -3.2%. In USD terms EUR credit is however down as much as -8.8% in total return terms.

Source: Deutsche Bank

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It’s been another volatile session for pot stocks broadly.

Day traders could be forgiven for feeling dazed and confused on Monday (for once, it may not have been due to overindulging in their favorite “commodity”). Shares of Tilray, Cronos and other pot stocks fluctuated between gains and losses – while shares of Aphria, another large Canadian pot stock plunged – following two scathing presentations from short sellers during a conference in New York City organized by famed short seller Whitney Tilson.

In what was probably the highlight of the Tilson conference, analysts from Hindenburg Research joined with the founder of Quintessential Capital Management to share their case for shorting Aphria, the fourth largest Toronto-listed pot stock by market cap. During their presentation, the companies accused Aphria of playing a “shell game” with international assets that the analysts argued were largely worthless.

New from us: Aphria—A Shell Game with a Cannabis Business on the Side

Proud to bring you this latest report in conjunction with @QCMFunds who is presenting this joint thesis at @KaseLearning right now. (1/x)https://t.co/DvHDhAqzKN $APHA

— Hindenburg Research (@HindenburgRes) December 3, 2018

Next short idea is Tilray $TLRY that’s two cannabis stocks if you’re keeping score at home

— Nathaniel E. Baker (@natbaker) December 3, 2018

According to Bloomberg, Leamington, Ontario-based Aphria has raised about C$700 million ($531 million) over the past four years and is the fourth-largest cannabis stock by market value.

In his presentation, AQM founder Gabriel Grego alleged that Aphria has created a mechanism to siphon off investor capital and transfer it to company insiders via “investments” in South America and the Caribbean. According to Grego, Aphria purchased these investments from shell companies controlled by Aphria insiders for “significantly higher” prices than had previously been paid. “Our target price is zero,” Grego said.

Grego said Aphria engineered a mechanism to siphon off money to companies held by insiders in South America and the Caribbean to the detriment of shareholders, according to the report. The short seller said Aphria purchased companies in Argentina, Colombia, and Jamaica in September from Scythian Biosciences Inc., now named SOL Global Investments Corp., which had acquired them shortly before at a “significantly lower” price from three Canadian shell companies.

The shell companies are linked to Andy DeFrancesco, chairman of Scythian-SOL and adviser to Aphria, according to the report. All three units can be traced back to Delavaco Group, DeFrancesco’s private equity company, according to the report. Their names were changed months before the takeover by Scythian, according to the short-seller report.

A spokesman for Aphria said QCM’s allegations were “false and defamatory” and said the company was planning a “comprehensive response.”

“Allegations that have been made by the short seller Quintessential Capital in the report that they published this morning are false and defamatory,” Tamara Macgregor, Aphria’s vice president of communications, said in an emailed statement. “The company is preparing a comprehensive response to provide shareholders with the facts and is also pursuing all available legal options against Quintessential Capital.”

While Aphria experienced the brunt of the selling – falling more than 30% after the AQM-Hindenburg presentation – Tilray, which gained notoriety after its shares went parabolic back in September before erasing all of their gains during the span of one hectic session, briefly sold off after Aristides Capital’s Chris Brown argued that the company’s shares are grossly overvalued because the market has so far failed to value the company like a “commodity business”.

However, Tilray shares turned positive later in the day following a report in the Financial Times that Marlboro producer Altria was in talks to buy the company.

The report inspired the following humorous comment.

Then they walked when they realized it’s a $10BN company with $30MM in revs?

— Hipster (@Hipster_Trader) December 3, 2018

Rounding out the day’s pot stock-related news, Reuters reported that Altria was in “early stage” talks to acquire Cronos Group, another Canadian pot producer, as it seeks to diversify its holdings.

Pot stocks have trended lower since Canada legalized recreational cannabis sales back in October. While the sector has largely suffered from a bubble-like influx of capital, concrete reports about a deal where an established beer or tobacco company buys a stake in a cannabis firm – like Constellation brands did with Canopy Growth – could send shares higher.

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Authored by Doug Kass via RealInvestmentAdvice.com,

“I will eat my hat if this means anything substantive”… as “neither side is fully ready for war, but neither side will budge.” – Michael Every, Rabobank’s Head of Asia financial markets

• Xi is the “Wolf of Wall Street”

• The weekend agreement may backfire

• We may have three months of uncertainty that freezes business decision making – U.S. economic growth may slow and not reaccelerate

• An explosive market advance based on this weekend’s U.S./China trade news may provide one of the best shorting opportunities since September, 2018

• He said, Xi said

• Last night I moved (with futures +48 handles) from a small net long exposure to a small net short exposure

• I plan to expand my short book on any further near term market strength

A “pump and dump” scheme is a well known securities fraud that involves artificially inflating the price of an owned stock through false and misleading positive statements, in order to sell the cheaply purchased stock at a higher price or to otherwise benefit from the declaration.

Over this weekend, the trade war between China and the U.S. temporarily ended with a truce in which the U.S. agreed to keep the rate on existing tariffs for an additional $200 billion of goods at 10% for another three months in return for greater purchases of American goods. (In addition, China’s policy towards Taiwan and a nuclear free North Korea was also agreed by Xi and Trump).

President Trump has heralded the deal as “incredible,” but like the pump and dumpers in the brokerage boiler shops in Boca Raton, Florida and Long Island of years ago, the agreement had little substance in the face of the forceful and powerful deal headwinds and China interests – which principally involve the very structure of China’s economy, the nation’s reputation and the Chinese party’s authority.

While the worst-case G-20 meeting scenario (never a very likely outcome) is off the table, I couldn’t disagree more with the market’s Pavlovian response (with S&P futures +48 handles as I write this missive on a plane to Los Angeles yesterday). Indeed, of the hopes for good news heading into the weekend, the proposed agreement was on the lowest rung of positives. (Remember that Trump, many months ago, had rejected a Chinese deal to buy more U.S. “stuff.”)

I see the “agreement” as nothing more than a Chinese “Trump and Dump” scheme (though the meeting was anything but a “cold call”) – full of sound and fury signifying nothing – which failed to make tangible progress regarding the core and deep rooted structural divides that separate business practices and other fundamental differences. (Including, but not restricted to intellectual property rights, forced technology transfers and public sector subsidies for strategic industries).

The deal was a “nothing burger.”

It still leaves us with 10% tariffs which are not helpful and fails to solve the underlying problems. Effectively, all the agreement did was to punt the ball for another three months.

No All Clear Signal

Indeed the “agreement” might cause more uncertainty and a slowdown in U.S. economic activity and capital spending
China has effectively executed a “Trump and Dump” scheme that will likely artificially raise the short term trajectory of stock prices as poorly positioned market participants reposition – only to recognize, in the fullness of time, that the buyers of stocks on the news have likely been duped.

This agreement comes at a time that the Chinese and American markets are on the precipice of Bear Markets. It’s soothing message, which to some, may result in buying a continued ramp in U.S. equities , may be nothing more than providing an opportunity for China to resume aggressive means to reaccelerate domestic economic growth (like reducing margin requirements last evening).

He Said, Xi Said!

Not surprisingly, there was no joint statement following Saturday’s dinner. China didn’t reference the 90 day deadline nor did the U.S. highlight the One China policy. Rather, the agreement itself has already been interpreted differently by both parties – based on the official responses from the two countries.

For the U.S. there is a real risk that the three month hiatus or cooling off period may have the absolute contrary results – it could serve to spur more business uncertainty – delaying purchases and capital expenditures. This comes at a critical time in which signposts of growth domestically and overseas are worrisome and during a continuing pivot of monetary restraint.

Bottom Line

“You only think I guessed wrong! … You fool! You fell victim to one of the classic blunders – the most famous of which is “never get involved in a land war in Asia” – but only slightly less well-known is this: Never go in against a Sicilian when death is on the line!” – Vizzini,The Princess Bride

China has executed the perfect “Trump and Dump” scheme. The President didn’t receive a phone call from someone just as devious as Stratton Oakmont’s Jordan Belfort – he sat over dinner with him!

Trump has bought (and has apparently persuaded others overnight) into Dollar Time Group and the Aquanatural Company at the top without any knowledge of the company with the hope of riches, the need to show a “deal” (Its been a bad few weeks with Jamal Khashoggi, Michael Cohen, a weakening of the U.S. economy, the downtrend in markets, etc.) and the desire to be more popular.

And so might investors have been duped who buy the post trade agreement euphoria (S&P futures are +48 handles at 6:30 pm on Sunday night ) – with the quixotic ease of a phony deal and “quick buck” anticipated.

The divergence in world views between China and the U.S. were not addressed on Saturday. That schism is fundamental, structural and the rift will likely be long lasting – measured in years not weekends.

It is also my view that this weekend’s trade agreement may serve to further slow down domestic economic growth as businesses grow more uncertain of the ultimate outcome and recognize that this trade dispute will be measured in years and not in weekends.

As I wrote last week:

“I have written much about trade over the last few weeks – most recently this week’s “Is Trump Manipulating the Market With His Frequent China-Trade Comments? #MUVGA!”

What follows is a great quote made in 1972 by Chinese Premier Zhou Enlai — it’s something to keep in mind when listening to opinions on the subject of China/U.S. trade.

When he was asked about the impact of the French Revolution (of 1789), he replied “It is too early to tell.”

That quote is from sixty years ago.

Unlike many, I believe the Chinese can outlast us in a trade war.

China is a patient civilization. The country takes the long view of history (often measured in hundreds of years) — as expressed in the witty and Oscar Wildean response above by Enlai.

While Americans are focused on 2020, the Chinese are focused on 2120!

The hardliners in the White House and the dopes on Wall Street don’t have a sense of history.”

I see nothing in this weekend’s agreement to alter the view that the dispute will be long lasting (with similar characteristics of the beginning of the 1948 “Cold War) and is likely to be more far reaching than trade. (See Spence’s two recent speeches at The Hudson Institute and at APEC, here and here

With both leaders facing their own problems, Xi got Trump to kick the can down the road for another 90 days without extracting much in return. Our President heralded the agreement as a victory (and he will likely voice that in tweets today about the market’s spectacular response) though he exacted only a temporary respite from what will likely be years of negotiations and rifts.

In the next few weeks (or even days), we may very well witness the best shorting opportunity since the end of January and September.

China has executed a perfect “Trump and Dump” scheme, buying more time (at little expense).

Don’t be duped, too.

Position: Short SPY

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One of the catalysts bolstering the overnight rally, which sent auto stocks surging both in the US and across the Atlantic, was a late night tweet by Donald Trump according to which “China has agreed to reduce and remove tariffs on cars coming into China from the U.S. Currently the tariff is 40%” without giving any further details.

This however prompted even more questions about the outcome of his meeting with counterpart Xi Jinping as this was the first time that this aspect of the US-China trade agreement had been unveiled.

On Monday morning, Treasury Secretary Steven Mnuchin confirmed Trump’s tweet, saying that China has agreed to eliminate tariffs on imported automobiles but declined to give details.

“The first part was to reduce the surcharge, but yes there have been specific discussions on where auto tariffs will come down to, but I’m not prepared to talk about the specifics,” Mnuchin told reporters outside the White House, leaving the mystery intact.

A little later, Trump’s chief economic advisor, Larry Kudlow, told reporters that the Chinese are “going to roll back their auto tariffs,” adding “that’s got to be part of the deal” talking back Trump’s definitive assessment that China had agreed to “reduce and remove” (which is it?) auto tariffs.

Speaking later, Kudlow added some more confusion when he said that he “assumes” China will put car tariffs on the table right away, a statement that certainly does not imply China had “agreed” to anything.

Meanwhile, from the Chinese side, there was little mention of car tariffs being part of a deal. In fact, there was no mention at all: in a briefing in Beijing a few hours after the tweet, China’s foreign ministry spokesman Geng Shuang declined to comment on any car tariff changes.

As Bloomberg notes, the uncertainty about a deal on car tariffs stems from the unusual nature of the G-20 negotiation. The outcome of the talks wasn’t recorded in a joint statement, and so the two sides have instead emphasized different results. China hiked its tariff on U.S.-made cars to 40% earlier this year in retaliation for tariffs Trump imposed on Chinese imports, and Beijing has made no announcement about reducing the car tariff.

Last week, China said that tariffs on U.S. autos would be 15 percent if not for the trade dispute, and it called for a negotiated solution. Chinese officials discussed the possibility of lowering tariffs on U.S. car imports before Xi met Trump in Argentina. But the magnitude and timing of such a reduction were unclear, a Bloomberg source said.

The U.S. currently charges a 27.5 percent tax on imported cars from China.

Of course, any breakthrough in the auto tariff front would be widely cheered by the market: as both domestic and foreign carmakers have long pleaded for freer access to China’s auto market, while its own manufacturers are trying to expand abroad. In April, China announced a timetable to permit foreign automakers to own more than 50 percent of local carmaking ventures.

In summary, confusion continues to reign over whether the US and China struck some deal to “reduce and remove” tariffs, even if for now the S&P auto sector is happy to buy first and ask questions later.

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Leaders of the so-called “Yellow Vest” movement have rejected demands to negotiate with the French government after President Emmanuel Macron ordered his prime minister to hold discussions, according to AFP. Macron and top officials are now in full damage control mode amid the most violent protests France has seen since 1968. 

Approximately 136,000 demonstrators donning yellow reflective vests were recorded across France on Saturday – of which approximately 5,500 protested in the French capital according to the interior ministry. The previous weekend saw 166,000 demonstrators, and 282,000 the week before that. 

This is France right now. You’ve heard media rip Trump for having a mid 40’s approval rating yet they’ve celebrated Macron like he’s a beloved world leader when he has a 27% approval and his country is rioting. The media may love him but the people don’t. pic.twitter.com/xVqZNXlCQq

— Robby Starbuck (@robbystarbuck) December 3, 2018

According to the interior ministry, 412 people were arrested in during Saturday’s violent clashes in the French capital, while 263 people were injured. The worst hit areas were the wealthy west and central Paris, where stores were smashed and looted, dozens of cars were burnt, and police forces were overwhelmed by Yellow Vest protesters. 

Amid the chaos, an 80-year-old woman waas killed when a police tear-gas canister was launched into her apartment window while she was trying to close the shutters. She was taken to a nearby hospital but died during an operation after suffering shock, according to a local media report. She has become the third casualty in the demonstrations which began three weeks ago. 

On Monday, Macron held an urgent security meeting – after which ministers said that while “no options have been ruled out,” they had not discussed a state of emergency as had been previously reported. 

Conservative leader Marine Le Pen who attended the meeting warned that Macron could become the first French president to order troops to open fire on his own people in 50 years, and that he should abandon his plan to raise taxes on fuel while lowering gas and electricity prices. 

The demonstrations, meanwhile, have had a noted effect on business in the region.

Finance Minister Bruno Le Maire met with business representatives to assess the damage caused to businesses over the weekend.

“The impact is severe and ongoing,” Mr Le Maire told the AFP news agency.

Some retailers had seen sales drop by around 20-40% during the demonstrations, while some restaurants had lost 20-50% of their takings, he added. –BBC

The protests have continued into Monday according to the BBC, which reports that about 50 Yellow Vest protesters blocked access to a major fuel depot in the port city of Fos-sur-Mer, which is close to Marseille – while gas stations across France have run out of fuel after restrictions on purchases were instated. 

As if things weren’t bad enough for Macron, on Monday French private ambulance drivers staged further demonstrations against several healthcare and social security reforms which they say could affect their jobs. 

Dozens of trucks formed a blockade from Paris’s Place de la Concorde to the French National Assembly.

One protester told the Reuters news agency: “[The reforms] will bludgeon us financially and destroy our companies. We’re going to have to fire people, that’s for sure.”

It is unclear if the ambulance drivers are part of the Yellow Vest movement – however recent polls have shown that most of France supports their cause.  

Similiar protests have broken out around Europe, as Yellow Vest demonstrations have spread to Belgium, Italy and the Netherlands. 

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Authored by Lance Roberts via RealInvestmentAdvice.com,

This past week, Mark Hulbert wrote an article discussing the recent drop in margin debt. To wit:

“Plunging margin debt may not doom the bull market after all, reports to the contrary notwithstanding.

Margin debt is the total amount investors borrow to purchase stocks, which historically has risen during bull markets and fallen during bear markets. This total fell more than 6% in October, according to a report last week from FINRA. We won’t know the November total until later in December, though I wouldn’t be surprised if it falls even further.

A number of the bearish advisers I monitor are basing their pessimism at least in part on this plunge in margin. It’s easy to see why: October’s sharp drop brought margin debt below its 12-month moving average. (See accompanying chart.)”

“According to research conducted in the 1970s by Norman Fosback, then the president of the Institute for Econometric Research, there is an 85% probability that a bull market is in progress when margin debt is above its 12-month moving average, in contrast to just a 41% probability when it’s below.

Why, then, do I suggest not becoming overly pessimistic? For several reasons:

1) The margin debt indicator issues many false signals

2) There is insufficient data

3) Margin debt is a strong coincident indicator.”

I disagree with Mark on several points.

First, margin debt is not a technical indicator which can be used to trade markets. Margin debt is the “gasoline,” which as Mark correctly states, drives markets higher as the leverage provides for the additional purchasing power of assets. However, that “leverage” also works in reverse as it provides the accelerant for larger declines as lenders “force” the sale of assets to cover credit lines without regard to the borrower’s position.

That last sentence is the most important. The issue with margin debt, in particular, is that the unwinding of leverage is NOT at the investor’s discretion. It is at the discretion of the broker-dealers that extended that leverage in the first place. (In other words, if you don’t sell to cover, the broker-dealer will do it for you.) When lenders fear they may not be able to recoup their credit-lines, they force the borrower to either put in more cash or sell assets to cover the debt. The problem is that “margin calls” generally happen all at once as falling asset prices impact all lenders simultaneously.

Margin debt is NOT an issue – until it is.

It is when an “event” causes lenders to “panic” that margin becomes problematic. As I discussed just recently:

“If the such a decline triggers a 20% fall from the peak, which is around 2340 currently, broker-dealers are likely going to start tightening up margin requirements and requiring coverage of outstanding margin lines.

This is just a guess…it could be at any point at which “credit-risk” becomes a concern. The important point is that “when” it occurs, it will start a “liquidation cycle” as “margin calls” trigger more selling which leads to more margin calls. This cycle will continue until the liquidation process is complete.

The last time we saw such an event was here:”

Importantly, note in the chart above, the market had two declines early in 2008 which “reduced” margin debt but did NOT trigger “margin calls.” That event occurred when Lehman Brothers was forced into bankruptcy and concerns over counter-party risk caused banks to cut their “risk exposure” dramatically.

Like early 2008, the recent declines have not sparked any real semblance of “fear.” The VIX, Interest Rates, and Gold have yet to demonstrate that a change from “complacency” to “fear” has occurred.

Mark’s second point was a lack of data. This isn’t actually the case as margin debt has been tracked back to 1959. However, for clarity, let’s just start with data back to 1980. The chart below tracks two things:

1. The actual level of margin debt, and;
2. The level of “free cash” balances which is the difference between cash and borrowed funds (net cash).

What is immediately recognizable is that reversions of negative “free cash” balances has led to serious implications for the stock market. With negative free cash balances still at historically high levels, a full mean reverting event would coincide with a potentially disastrous decline in asset prices as investors are forced to liquidate holdings to meet “margin calls.”

The relationship between cash balances and the market is better illustrated in the next chart. I have inverted free cash balances so the relationship between increases in margin debt and the market. It is not hard to imagine what a reversion to positive cash balances would do to the stock market.

As stated, the data goes back to 1959. However, prior to 1980 margin debt, along with every other form of debt, was not widely utilized both due to high borrowing costs and a “post-depression era” mentality about debt. Nonetheless, the chart below tracks the percentage growth in debt relative to the S&P 500 (both have been adjusted for inflation).

The next chart is the same as above but is only from 1959-1987 so you can more clearly visualize the impact of margin debt on asset prices.

(Most people have forgotten there were three back-t0-back bear markets in 1960’s-1970’s as interest rates were spiking higher. The 1974 bear market was the one that simply wiped everyone out!)

Again, what we find is a correlation between asset prices and margin debt. When margin growth occurs extremely quickly, which coincides with more extreme investor exuberance, corresponding unwinds of the debt has been brutal.

Let’s go back to Mark’s original discussion with respect to the 12-month average. If we take a longer-term look at the data we find that breaks of the 12-month moving average has provided a decent signal to reduce equity risk in portfolios (blue highlights). Yes, as with any indicator, there are times that it doesn’t work (purple highlights).However, more often than not, reducing equity risk when the 12-month moving average was broken saved you when it counted the most.

It’s All Coincident

Mark is absolutely correct that “margin debt” is a “coincident” indicator. Such should not be surprising since rising levels of margin debt are considered to be a measure of investor confidence. Investors are more willing to take out debt against investments when shares are rising and they have more value in their portfolios to borrow against. However, the opposite is also true as falling asset prices reduce the amount of credit available and assets must be sold to bring the account back into balance.

I both agree, and disagree, with the idea that margin debt levels are simply a function of market activity and have no bearing on the outcome of the market.

By itself, margin debt is inert.

Investors can leverage their existing portfolios and increase buying power to participate in rising markets. While “this time could certainly be different,” the reality is that leverage of this magnitude is “gasoline waiting on a match.”

When an event eventually occurs, it creates a rush to liquidate holdings. The subsequent decline in prices eventually reaches a point which triggers an initial round of margin calls. Since margin debt is a function of the value of the underlying “collateral,” the forced sale of assets will reduce the value of the collateral further triggering further margin calls. Those margin calls will trigger more selling forcing more margin calls, so forth and so on.

Given the lack of “fear” shown by investors during the recent decline, it is unlikely that the recent drop in margin debt is a function of “forced liquidations.” As I noted above, it will likely take a correction of more than 20%, or a “credit related” event, which sparks broker-dealer concerns about repayment of their credit lines.

The risk to the market is “when” those “margin calls” are made.

It is not the rising level of debt that is the problem, it is the decline which marks peaks in both market and economic expansions.

Currently, the “bullish bias” remains intact and the recent volatility in the market has not shaken investors loose as of yet. Therefore, it is certainly understandable why so many are suggesting you should ignore the recent drop in margin debt.

But history suggests you probably shouldn’t.

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