A ‘Huge Storm’ of Credit Threatens Stock Investors

As 2018 proves much more volatile for equity investors than most recent years, some experts on the Street view a soaring amount of consumer and corporate debt as a major threat to the bull market. 

According to Brad Lamensdorf, manager of the AdvisorShares Ranger Equity Bear ETF (HDGE), a "huge storm" should prove "nasty" for market bulls. The hedge fund manager's Ranger Equity Bear fund has lost nearly 13% annually over the past five years, the inverse of the S&P 500's positive return. (For more, see also: Why the 1929 Stock Market Crash Could Happen in 2018.)

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“How much credit is out there, borrowed against stock portfolios? Trillions of dollars,” wrote Lamensdorf in a report co-written with John Del Vecchio, and as reported by MarketWatch. “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 views a forthcoming tipping point, similar to the dot.com bubble of 2000 and the housing bubble in 2008, occurring as soon as this year, as investors continue to increase their debt to fund their stock portfolios. When a certain threshold is passed, the environment will be terrible for sellers, noted the analyst, writing that "shedding assets when everyone else is feeling pain leads to terrible deals for the seller."

Crash Will Be 'Nastier' Due to High Speculation

He related the historically high level of credit balances at the New York Stock Exchange (NYSE) and the fact that investors are "gorging like pigs at the trough," to similarly negative credit balances during the top out of the tech bubble in the early 2000s, which he noted turned positive after the crash. Likewise, the negative credit balance of the housing bubble flipped into the largest positive balance that the market had seen in decades as the market crashed a few years later. 

“Now, as the stock market has practically gone parabolic, investors have taken on a massive amount of margin debt,” he said. “When this margin debt is unwound, like it was during the last two bear markets, it’s going to be nastier than before because there is so much speculation in the system...The pain is coming and unavoidable.”

Biggest Investors Have Most to Lose, Most to Gain

While a number of small setbacks haven't shaken investors too much, Lamensdorf noted that "like boiling a frog in a pot, it all adds up." He added that investors with the largest portfolios of course have the most to lose, but also the most to gain, given "they can navigate the market unemotionally and be greedy when others are fearful."

In a recent Investopedia story by Mark Kolakowski, dated April 6, he outlines how consumer and corporate debt may fuel the next market crash. He cited a Barron's interview with economic researcher firm Macromaven's founder Stephanie Pomboy. She highlighted the fact that households are borrowing a whopping $0.90 for every $1 that they spend, up from $0.40 four years ago, with an increasing level of household debt service, at $75 billion, which will "eliminate the entire effect of the tax cut." Meanwhile, households savings have fallen below pre-housing bubble levels, costs facing consumers are rising, and a $4 trillion pension deficit looms. (For more, see also: What Will Trigger the Next Stock Market Crash.)