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Stock Market Lazes Happily on a Powerful Time Bomb, and the Fed Begins to Worry

Stock Market Lazes Happily on a Powerful Time Bomb, and the Fed Begins to Worry

Pointing at “excesses,” “distortions,” and “imbalances.”

Margin debt in the stock market hit another record, $561 billion at the end of October, up 16% from a year ago, the New York Stock Exchange reported on Tuesday. Margin debt and the stock market move together. And even on an inflation-adjusted basis, the surge has been breath-taking.

This chart shows margin debt (red line, left scale) and the S&P 500 (blue line, right scale), both adjusted for inflation to tune out the effects of the dwindling value of the dollar over the decades (chart by Advisor Perspectives):

Stock market leverage is the big accelerator on the way up. Leverage supplies liquidity that has been freshly created by the lender. This isn’t money moving from one asset to another. This is money that is being created to be plowed into stocks. And when stocks sink, leverage becomes the big accelerator on the way down. When stocks are dumped to pay down margin debt, the money from those stock sales doesn’t go into another asset and doesn’t sit around as cash ready to be deployed and it doesn’t go into gold bars either. It just disappears.

Even the Fed is now worried about margin debt and a slew of other factors not related to consumer price inflation but to assets, asset prices, and debt.

The latest was Dallas Fed President Robert Kaplan on Monday who, in discussing financial and economic imbalances, specifically addressed the “record-high levels” of margin debt.

His premise is that “there are costs to accommodation in the form of distortions and imbalances,” and when “excesses ultimately need to be unwound, this can result in a sudden downward shift in demand for investment and consumer-related durable goods.” Kaplan:

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