Several years of very low interest rates have achieved the desired effect of encouraging Americans to borrow, spend, and boost the economy.
But as borrowing costs rise, it is increasingly important to track how easily people are able to finance new debt or repay old obligations. Among those with the most at stake are the top one percenters, who’ve borrowed to buy stocks and used their portfolios as collateral for other lines of credit, according to Brad Lamensdorf, a portfolio manager at Ranger Alternative Management and an outspoken market bear.
“Failure to act on warning signs could be the difference between a comfortable retirement or years of slaving away at work,” he said in the monthly Lamensdorf Market Timing Report.
One key amber sign is that borrowing to buy stocks is at historic levels. “Investors as a whole are gorging like pigs at the trough,” Lamensdorf said. It’s a trend that even Berkshire Hathaway Chairman Warren Buffett warned about in his most recent shareholder letter, saying it was a way for investors trying to get rich quickly.
Lamensdorf observed that negative credit balances in margin accounts, offered by brokerages so investors can borrow to buy stocks, are near the lowest levels going back to at least the 1980s, according to data from the Financial Industry Regulatory Authority.
Lamensdorf Monthly Timing Report
So-called securities-based loans allow investors to use their portfolios as collateral for credit lines that can be used for just about anything except buying more stocks. The interest rates for these loans are typically benchmarked against the London Interbank Offered Rate, or LIBOR, which banks use to borrow dollars from one another. It’s set to be replaced following a massive rigging scandal, although that’s not until 2021.
Meanwhile, it’s rising. On a three-month basis and in dollar terms, it was near 2.32% on Friday, the highest level since September 2008 according to Bloomberg data.
“Nearly every day it is getting more and more expensive to maintain these lines of credit that wealthy investors have been using,” Lamensdorf said.
“As interest rates creep up and more portfolios have been used to finance asset purchases, a huge storm can be created if stocks and bonds take even a minor dip,” he added.
That’s because if stock prices fall, brokers may call upon investors who’ve borrowed for their portfolios to raise cash by selling. Indeed, some strategists cited margin calls as one reason for the depth of the stock market’s 10%+ correction in February.
“What should be down 10% in normal markets might be down 30% in a highly levered market,” Lamensdorf said. “With trillions out there, things could get nasty. What’s the tipping point? It’s hard to say but rates have really shot higher in the last year or two and things are getting dicey.”
What’s also worrying, according to Lamensdorf, is that the borrowing binge has been accompanied by a decline in savings. Net national savings as a percentage of economic output, which tallies savings for consumers, companies, and the US government, recovered from the recession but peaked in 2014 and is on the decline again.
“Investors with sizable portfolios have the most to lose,” Lamensdorf said. “But, they also have the most to gain if they can navigate the market unemotionally and be greedy when others are fearful as the next bear market unfolds.”
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