A record that’s gone largely unnoticed. Investor confidence is at an all-time high, but so is leverage. What if the risk were no longer in the banks, but in investors’ portfolios?
Let me give you a quick tip, so make good use of it: margin debt is at a record high. It may seem like a trivial statement, but it actually hides an unpleasant truth.
Margin debt reflects how much investors have borrowed from their brokers to increase their exposure to equities. In other words, the market is leveraging itself. And when leverage becomes excessive, even a small shock can throw it off balance. This means investors’ portfolios may be stretched too thin, and if we really want to rub salt in the wound, this historically happens before a market adjustment.
But let me explain.
What is margin trading (and why you should know about it)
A margin trade is, simply put, a purchase financed partly with debt. The investor doesn’t pay entirely with his own capital, but uses funds borrowed from the broker to increase his exposure. In exchange, he pledges the purchased securities or other financial assets as collateral.
If the stock price rises, the gain is amplified: leverage multiplies returns. But if the market falls, leverage also multiplies losses. And here a key element comes into play: the margin call. When the portfolio value falls below a certain level, the broker asks for new funds or automatically sells the securities to cover the debt. This is the mechanism that, in the event of panic selling, transforms a moderate decline into a full-blown sell-off.
What is margin debt (and why it’s dangerous when it grows too much)
Margin debt is the total amount of money borrowed by investors for these types of transactions. It is an indirect measure of the market’s overall level of leverage.
When it rises, it means investors are increasingly betting on a rise in stocks, which can be a sign of euphoria or complacency.
So far, the US financial regulator (FINRA) that oversees brokerage firms has reported that total margin debt rose for the fifth consecutive month in September, reaching a new all-time high. In numbers: $1.13 trillion. It appears that, in recent months, margin debt has actually grown at twice the rate of the overall market. And this is a sign that should ring more than one alarm bell.
Why? Because it means that the market rally is being fueled not only by new real capital, but also by credit and leverage. In other words, investors are buying stocks with money they don’t have, pushing an already expensive market even higher.
What does high margin debt really mean
At first glance, high margin debt may seem like good news. Ultimately, it indicates confidence — that investors believe in the upside and have enough risk appetite to take on leverage. And indeed, if we look at the situation optimistically, it means the market is extremely confident: the Fed is cutting interest rates, while the US economy continues to grow at a rate above 3% in the third quarter.
A combination that, apparently, justifies optimism.
But the other side of the coin is more disturbing.
When margin debt increases for many consecutive months, history shows that it is often the secret ingredient of bear markets. It’s no coincidence that similar peaks were seen ahead of the 2000 dot-com bubble and the 2008 financial crisis.
At those times, investors were convinced that nothing could go wrong.
Then all it took was a spark—a profit warning, a credit crunch, or an unexpected piece of macroeconomic data—to trigger automatic selling, triggering the chain of margin calls.
The declines amplified in a cascade, dragging down the entire market.
How do we get to these levels of risk
It unfolds like this: slowly, then suddenly.
It all starts when easy money and strong returns make it seem like risk has disappeared.
Investors increase their positions, brokers loosen requirements, and leverage becomes a habit.
Meanwhile, accommodative monetary conditions, like those we see today, further encourage risk-taking.
When rates fall, borrowing costs decrease, and the temptation to borrow to buy securities grows. But this mechanism only works as long as the market rises. The moment something goes wrong—an unexpected rise in rates, an inflation print, a corporate default—the losses multiply and the system reacts like a rubber band that’s stretched too far: it snaps.
The hidden risk in your portfolio
This is why the next crisis may not originate in the banks, but in investors’ portfolios themselves. Systemic risk today is widespread, broadly dispersed, and largely invisible: no longer concentrated in large institutions, but dispersed in the margin accounts of retail investors.
This, mind you, doesn’t mean there will be imminent declines.
Rather, it means that the market is tense enough to make any negative news unstable. And we all know how it works when markets are built on leverage and derivatives: small negative changes are amplified, triggering margin calls that force further sales and fuel additional fears, in a vicious cycle of forced liquidations.
It’s a technical mechanism, not an emotional one. But that’s precisely why it’s dangerous: it works automatically, without giving you time to think. And that’s how a 2% decline can turn into a 10% decline in just a few days.
The lesson is simple but powerful: the next crisis might not come from central banks, mortgages, or corporate credit. It could stem from the leverage investors themselves carry in their portfolios, invisible as long as markets keep rising, but ready to explode at the first shock.
Original article published on Money.it Italy 2025-10-30 07:52:00. Original title: La prossima crisi non nascerà dalle banche. Ma dal tuo portafoglio
