- Today, the S&P stock index is reaching its 17th historic high this year, April 8, and "borrowed money" seems to be one of the driving forces behind the rise.
- Figures from late February indicate that investors have reached a new historic high in terms of the amount of money that they have borrowed on their portfolios.
- And, these borrowings are expected to go even higher as the Federal Reserve continues to help "underwrite" the advances taking place in stock prices.
- Investors are placing a lot of confidence in the Fed, a confidence built up over the last eleven years, and the Fed's ability to sustain high stock prices.
Credit has been one of the major factors that has been driving the stock market over the past decade. One of the major reasons for this is that Ben Bernanke, the Chairman of the Board of Governors of the Federal Reserve System, during the Great Recession (2007-2009) and beyond, had done significant research on the Great Depression while he was a professor at Princeton University.
Mr. Bernanke's research led him to the belief that the economic recovery following the Great Recession could be driven by consumer spending if the Fed could produce a wealth effect caused by a rising stock market that would result in the increase in the wealth of consumers.
Mr. Bernanke and the Federal Reserve succeeded in their efforts.
Not only did Mr. Bernanke succeed in his efforts to stimulate the stock market and hence stimulate the U.S. economy, but this program was followed by his successors Janet Yellen and Jerome Powell. The powerful rise in the stock market following the recovery from the Great Recession can be attributed to the continued support of the market by Ms. Yellen, Mr. Powell, and the Fed.
A good part of the credit stimulus for the stock market came from increases in investors borrowing against the investment in their securities. But, these borrowing have reached new heights.
At the end of February, 2021, "investors had borrowed a record $814 billion against their portfolios."
The increase was 49 percent from one year earlier and was the fastest annual increase since 2007, when margin credit in the stock market was less than $200 billion. Margin credit has increased almost four-fold since Mr. Bernanke began his recovery program.
The Rise Since 2010
One can see from the accompanying chart that this rise was not a one-time event. These borrowings have been increasing at a pretty steady pace, with the exception of the 2019 period, since the economic recovery following the Great Recession began.
Total Margin Debt
Note: Figures reflect end-of-month debit balances in brokerage customers securities margin account.
The path of the S&P 500 Stock Index over roughly the same period of time. Both charts show fairly steady increases in both series. The one exception is the downturn in the stock market in the first quarter of 2019, the time when the Coronavirus pandemic hit the U.S. economy causing a recession and also causing a significant drop in the stock market.
Source: Federal Reserve Bank of St. Louis
You can see that total margin debt dropped off during the same period as stock market prices dropped.
But, you can also see the significant increase in total margin debt that parallels the subsequent rise in the stock market.
This is important, because it reflects the growing realization by investors that the Fed was helping to underwrite the rise of the stock market and that investors needed to keep their eyes on the Fed to make sure the central bank stayed with this policy.
The shift to this policy did have a significant impact upon investor behavior during this period. Because the steady Fed support during this time result in a steady rise in stock prices in general, there was a consequent shift in invested funds during the period from investment funds that emphasized "active" portfolio management, to investment funds that tended to be "passive" in nature. Investors didn't want to be paying for services that were not providing them with significant additional returns.
And, investors have placed relatively more money in "passive" funds ever since.
Of course, borrowings can take place for reasons other than buying more stock. And, it is not unusual for borrowings to increase with an increase in stock prices as some investors use these loans to pay for other expensive assets like cars and houses.
Still, the majority of the borrowing does go for additional stock purchases and the data available seem to indicate that the investors that most use margin debt for purchasing more stock, tend to be the wealthiest stock owners.
That is, investors with less overall wealth will use margin debt to pay for some larger assets over time, and, hence, enable themselves to acquire more expensive items, but also to lower their interest costs.
Wealthier investors, larger investors, tend to use more margin debt to support their activity. According to Alexander Osipovich and David Benoit, writing in the Wall Street Journal, not only do the largest players use margin debt to support their stock purchases, but they also use other tools to "amplify their bets," tool like derivatives.
This information is usually not available to review in a timely manner, but comes to light, according to Mr. Osipovich and Mr. Benoit "after a bet goes spectacularly wrong."
The Role Of The Federal Reserve
These data just reinforce the claim that the Federal Reserve is playing a major role in the performance of the stock market. This was not the case before the Great Recession. The current market reliance on Federal Reserve support came about because of policy changes that were brought about, beginning with Mr. Bernanke.
But, this emphasis is self-reinforcing. The more investors believe that the Fed is instrumental in a rising stock market, the more they focus upon whether or not the Fed is there to support a continually rising stock market.
Chairman Powell seems to have actually raised the ante in the Fed.
The Federal Reserve, especially since February 2020 has injected massive amounts of money into the financial system. One can see that the trough of the stock market in early 2020 and the trough in margin debt in early 2020 coincide very closely.
Edward Yardeni president of the consulting firm Yardeni Research, is quoted in the Wall Street Journal article as saying, that margin debt "fuels bull markets" and "the further that this stock market goes, the higher that margin debt will go…."
Rising debt is cumulative. As the Fed pumps money into the financial system, debt increases, which results in more debt increasing, which results in more debt increasing, and so on.
It is no wonder that the S&P 500 Stock index has already hit 16 new historic highs this year. And, given the trading going on before noon on this Thursday, April 8, another new high will be hit today.
So, the stock market continues to climb and "borrowed money" is certainly one of the factors that is driving these gains. The stock market did not behave in this way before Mr. Bernanke changed the game plan.
This article was written by
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