In the last days of 2012 we penned an article describing the current situation of the market as follows: “Margin Debt Soars To 2008 Levels As Everyone Is “All In”, Levered, And Selling Vol.” Today, Bloomberg catches up with this rather critical topic, and confirms that the buying power of the biggest marginal traders left in the market who do not recycled deposits into stocks – hedge funds – is nothing more than debt piled upon debt, as “Leverage among managers who speculate on rising and falling shares climbed to the highest level to start any year since at least 2004, according to data compiled by Morgan Stanley.” BBG also recaps what our readers already know: “Margin debt at NYSE firms rose in November to the most since February 2008, data from NYSE Euronext show.” In other words: everyone is all in and levered. And soon, in about two weeks, Bloomberg will figure out that everyone, or at least a central bank here or there, is, indeed, “selling vol.“
Gross leverage, a measure of hedge fund borrowing that shows how much their holdings exceed the cash invested by clients, was 153 percent in the week ended Jan. 4, up from an average of 152 percent in 2012 and 143 percent a year ago, according to data from New York-based Morgan Stanley. The level has averaged 143 percent since 2005, the data show.
Managers are borrowing more amid a 15 percent rally in the S&P 500 since June, a gain that was mostly missed by professional investors who speculated shares would fall, according to data from Hedge Fund Research Inc. and International Strategy & Investment Group.
Borrowing increased as President Barack Obama and Republican lawmakers reached an agreement averting more than $600 billion in automatic tax increases and spending cuts.
Sadly, Bloomberg’s conclusion is off:
The rising use of borrowed money shows that everyone from the biggest firms to individuals is willing to take more risks after missing the rewards of the bull market that began in 2009. While leverage means bigger losses should stocks decline, investors are betting that record earnings and valuations 9.8 percent below the six-decade average will help push the Standard & Poor’s 500 Index toward the record it set in October 2007.
“The first step of increasing risk is just going long, the second part of that is levering up in order to go longer,” James Dunigan, who helps oversee $112 billion as chief investment officer in Philadelphia for PNC Wealth Management, said in a Jan. 8 telephone interview. “Leverage increasing in the hedge-fund area suggests they’re now getting on board.”
What near record leverage means is that hedge funds have absolutely zero tolerance for even the smallest drop in prices, which are priced to absolute and endless central bank-intervention perfection – sorry, fundamentals in a time when global GDP growth is declining, when Europe and Japan are in a double dip recession, when the US is expected to report its first sub 1% GDP quarter in years, when corporate revenues and EPS are declining just don’t lead to soaring stock prices.
It also means that with virtually all hedge funds in such hedge fund hotel names as AAPL (the stock held by more hedge funds – over 230 – than any other), any major drop in the price would likely lead to a wipe out of the equity tranche at the bulk of AAPL “investors”, sending them scrambling to beg for either more LP generosity, or to have their prime broker repo desk offer them even more debt. And while the former is a non-starter, the latter has so far worked, which means that most hedge funds have been masking losses with more debt, which then suffers even more losses, and so on.
Is this sustainable? Find out soon, perhaps in as soon as one month, when it will finally be up to the flailing market, not some trillion dollar nonsense, to get Congress to a debt-ceiling compromise (because it is not different this time). It is at that point that we will find out just how much the surge in leverage is due to optimism, and how much due to being held hostage by a market in which to keep up with the beta rally one has no choice but to layer debt upon debt upon debt to pretend alpha still works in the New Normal.
Or else: “career risk.“