(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
April 15 Calling the stock market downdraft a
correction contained to technology may be both optimistic and
With Federal Reserve aid to the stock market ebbing, and
margin debt at all-time highs, what started with the most
expensive stocks could easily do much damage to more
Last week was the worst for the tech-heavy Nasdaq index
since June 2012, and though all major U.S. indices
finished the week lower the most striking losses were among
shares which had enjoyed very strong upward momentum. Twitter
is down more than 40 percent from its high this year,
while Netflix is off 27 percent and Facebook
nearly 20 percent. Overall social media stocks, which rose 65
percent last year, are down 15 percent so far this year.
There is a temptation when tall poppies are cut down for
those of us with more exposure to the real rather than virtual
economy to try to reason that the scythe will not bother with
In this case there are some reasons to worry.
It is probably not a coincidence that the flagging of the
stock market, which is slightly down this year after surging
since quantitative easing began, has happened at the same time
as the Fed commenced its plan to taper bond buying.
Bond buying was a boost to financial markets, but one whose
benefits were disproportionately felt by riskier instruments.
Riskier stocks did better than safer ones, by and large, and
social media and biotechnology companies are among the riskiest.
While the unwinding of that benefit quite naturally will be
felt first and hardest by those companies with the most
stretched valuations, QE was, in practice, a policy which
encouraged risk taking of all sorts. So while you might expect
the shares of companies which sell the necessities of life to do
better than technology high flyers as QE unwinds, the overall
pressure felt by stocks, which are inherently riskier than
bonds, will be downward.
That was exactly the case in 2000 and 2007; and though stock
market valuations now are not as intensely crazy as they were in
2000 or the economy as blithely oblivious to the dangers of debt
as it was in 2007, that does not mean that this time the broader
market will be spared.
MR MARGIN ON LINE 1
One thing which arguably is flashing as red a sign as it
ever has is margin debt - money borrowed to buy securities.
Margin debt hit an all-time high in February, according to the
most recent reading from the New York Stock Exchange, up 27
percent from the year before and nearly 70 percent over two
While some margin borrowing can be used to bet against stock
gains, the overall historical trend is for margin borrowing to
trace the lines of exuberance in the stock market. Margin debt
peaked, at lower levels, just before the tumble of 2000 and just
after things began to get hairy in 2007.
Again, the likelihood is that margin buying is concentrated
among shares in those companies which have soared highest,
fastest. If margin debt begins to decline, as indeed the data
may show it already has once it is released, those momentum
shares will fare worst.
But this will likely be a difference in degree rather than
direction. Margin borrowers don't only sell the shares they have
borrowed to buy when under pressure, but also those shares they
own which have held more of their value.
Hedge funds too are borrowing more money to invest, raising
the potential for sharp market moves. Hedge funds' weighted
average ratio of gross assets to capital recently hit 1.70, just
above the previous peak hit in, you guessed it, 2007.
None of this is by any means foreordained. New peaks in
leverage and debt can continue to be made for quite some time,
and economic growth could prove to be surprisingly strong now
that the snows of winter have melted. In other words, stocks
could continue to go up for valid or invalid reasons.
If anything the chief difference between today and 2007 or
2000 is not the story behind the technology or the mania for
property. It is instead that we all know that, to some
unquantifiable extent, the rally of the past several years has
been engineered by official policy.
While bubbles like those in dotcom and property pop,
official policy tapers, and does so with lots of fair warning.
That argues for continued pressure downward in stocks, which
will be felt across the market. Not a rout but a taper.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)