In the short term, exuberance is infectious. The more the market rallies, the more risk investors want to take on. The issue with margin debt is that when an event eventually occurs, it creates a rush to liquidate holdings. Since margin debt is a function of the value of the underlying “collateral,” the forced sale of assets will reduce the value of the collateral. The decline in value then triggers further margin calls, triggering more selling, forcing more margin calls, and so forth.
Margin debt levels, like valuations, are not useful as a market-timing device. However, they are a valuable indicator of market exuberance.
While it may “feel” like the market “just won’t go down,” it is worth remembering Warren Buffett’s sage words.
“The market is a lot like sex, it feels best at the end.”
Lance Roberts
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