Much like mortgage debt is to home prices, equity investor margin debt is to stock prices. With the Dow rising 25% and hitting new record highs every fourth day on average during 2017, borrowings for stock purchases have been hitting new records in tandem. The Fear of excessive margin debt by stock investors causing a climax of irrational exuberance seems perpetually elevated throughout this long Bull market. Sensational headlines sell, but often ignore context. In the real world it’s common for assets and debt to move together as greater wealth allows increased nominal borrowing. Higher home prices coincide with larger mortgages. The important context is the rate and ratios of risk and return. While margin debt has surpassed another new record at the January peak in stock prices, the net worth of households and stock markets have risen commensurately. In fact, even though stocks are about 45% higher than 4 years ago, the ratio of margin debt (smoothed) to stock market value has fallen modestly. Far from irrational exuberance of excessive debt financed stock market gains, margin borrowings have remained steady.
Another way to look at this stock market debt burden as it relates to market risk is the comparison of home mortgages. Obviously mortgage debt should continue rising in the long term with home values, but in the early 2000’s mortgage debt rose at an alarming rate as imprudent risk was encouraged. As long as the cost to service this mortgage debt and those defaulting on their debt are stable to lower, then the housing boom is sustainable. When the cost of monthly mortgage payments and delinquencies surged from 2005 to 2007 we had significant warning that trouble was near. Over the recent 9 years of economic expansion, home buying has returned with new record levels of mortgage debt as of the 1st quarter of 2018 (estimated). However, delinquency rates continue to fall as the income to service the low interest mortgage debt remains near multi-decade lows. Eventuality higher interest rates will turn all these lines higher and raise the yellow flag for housing, the economy and the stock market.
