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Block Trade Mess Brings Intense Debate Over “Leverage Gone Wrong”

(Bloomberg) – What could be the biggest margin call in history is ringing new alarm bells on Wall Street among those concerned about hidden leverage and the potential to fry the financial system on the shares of Archegos Capital Management of Bill Hwang have been looking for other areas of the surplus – from margin debt to options to bloated balance sheets – after stocks at the center of the fiasco fell and investment banks warned of losses. As with most things in the markets, opinions differ: Hwang’s troubles are portrayed as anything from the initial stage of a long overdue takeover to a single instance of a rampage involving risks. While Wall Street may have bypassed a systemic catastrophe, the explosion is an example of “leverage that went wrong when the signs threatened,” said Sameer Samana, senior global market strategist at the Wells Fargo Investment Institute. Overall, the system is now in place “Said Samana regarding broker accounts, options and loans. “If a wider retreat in the equity markets were to take shape, especially in the most prevalent areas of technology and tech-related stocks, a much bigger unwind would have to take place.” At least on Monday, the S&P 500 index has barely been in the last few weeks than that As stocks hit new highs, investors pointed to a worrying trend among brokers: rising margin debt, which stood at $ 813 billion at the end of February, historically high (numbers are delayed to report). What is sometimes lost in the discussion is that such debts almost always increase with the value of stocks. “It would be reasonable to look at this and say that we currently have a normal amount of margin debt in the system that the market is for,” said Arthur Hogan, chief marketing strategist at National Securities Corp. ” Little do I know that this would have been a clear signal of what is going on in some of these media stocks and would send a warning signal because you would, I suspect that in a rising market, margin debt will be higher. “However, according to Jason Goepfert, President of Sundial Capital Research, not every insight into the phenomenon is comforting. Assuming it will top $ 831 billion when this month’s numbers are reported in April, margin debt will have increased more than 70% year over year, one of the largest expansions since 1931. That means the change in debt compared to the previous year, the change in the S&P 500 compared to the previous year will have exceeded the previous year by more than 20 percentage points. “This type of excessive and sustained debt growth, both in absolute and relative terms, has been a boogeyman for Forward Returns,” Goepfert wrote in a recent statement to clients. “The most effective use of the data, both up and down, was the rate of change, also relative to the S&P. And so it becomes a much bigger problem. “Options FrenzySpeculative mania in the options market has also fueled bubble warnings for most of a year. Call contracts, where bulls pay a fraction of the stock price to bet it will go up, have become the toy of newly-bred day traders whose enthusiasm for short-term options is thought to have sparked a series of bullish feedback loops, “When you get into In a bull market with lots of liquidity, you get into some overconsciousness and some investors become less vigilant, ”said Keith Lerner, chief market strategist at Truist Advisory Services. “It suggests a degree of confidence.” However, the volume of calls, which has decreased from the highs in February, suggests that excitement for the products is waning. In the last 20 days, an average of over 23.6 million calls were made on US exchanges. While it’s still historically high, it’s a drop of nearly 29 million at the end of February. Credit Risk Written Off Companies that have borrowed have been powerfully rewarded in the stock market. Stocks in a basket defined by their high leverage are up over 17% year-to-date and are among the best this year among 17 quantitative styles tracked by Bloomberg. On the other side of trading, profitability is one of the worst performing factors. These stocks show losses of over 5%. Gold Sachs Group Inc. data tells a similar story: S&P 500 companies with weak balance sheets are on track, beating those with more stable finances by more than 17 percentage points this quarter – the largest margin of outperformance since at least 2006 Taken together, such statistics can be used to paint a picture of a market so frothy that investors are willing to ignore concerns about credit risk. But it is also true that these companies – those hardest hit by the coronavirus – will benefit the most from what is known as reopening trade as vaccines are administered and economic activity picks up. Coupled with the combined power of federal tax aid and the Federal Reserve’s seemingly endless bond purchases, the weakest links in the stock market can have the biggest boom. “These were the companies that investors were most concerned about not to survive and therefore tended to be a relief rally,” said Truists Lerner. “When the Fed has so much monetary stimulus and support, investors are more confident that it won’t be systematic.” High Hedge Fund Leverage It’s not just Hwangs Archegos who have loaded themselves with borrowed money to do business. According to the Treasury Department’s Office of Financial Research, the average leverage of the 10 largest hedge funds was 15.9 as of June 2020. While that number has declined from a high of 24.6 in June 2019, it’s well above the average of 5 for the next 40 largest funds. This number dwarfs the level of leverage Hwang operated with. Market participants estimate that the family office’s total assets have grown to $ 5 billion to $ 10 billion, while total positions may have exceeded $ 50 billion. While the largest hedge funds may have more leverage than Archegos, it is important to consider what resources they have been leveraging, according to George Pearkes of Bespoke Investment Group. For example, focusing less leverage on a handful of stocks is much riskier than putting a larger amount of borrowed money into instruments like government bonds or currencies. “When an asset is less volatile, more leverage can be safely applied.” said Pearkes, a global macro strategist for the company. “And that’s what generally happens with larger funds.” More articles like this can be found at bloomberg.com. Sign up now to stay up to date with the most trusted business news source. © 2021 Bloomberg LP

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