Why a borrowing binge by investors is a warning sign for the stock market

By Christine Idzelis

The growth rate in margin debt suggests conditions in the U.S. stock market are increasingly fragile, warns Leuthold Group

The U.S. stock market kicked off this week with losses.

Investors are increasingly borrowing to buy stocks, a reflection of greed in the stock market as they seek to amplify returns with margin debt. The growing pile of borrowed money has some on Wall Street nervous.

The recent jump in margin debt, or borrowing done by investors through their brokerage firms using their account balance as collateral, suggests conditions in the U.S. stock market are increasingly fragile, according to Scott Opsal, chief investment officer at the Leuthold Group. While the level of margin debt has swelled to around $1.4 trillion, it's the rate of growth that is more relevant here. That metric is currently signaling that investors should tread carefully, Opsal said in a phone interview Monday.

The roughly 54% growth rate in margin debt over the 12 months through May has Opsal concerned about "overconfidence" on the part of investors.

The chart below tracks past spikes in margin growth similar to what investors are seeing today. They have corresponded with previous market tops in 2000, 2007 and 2021, according to Leuthold.

It appears "investors have the pedal to the metal" at borrowing to invest in the stock market, said Opsal. He cautioned that historically, when the margin-debt growth rate accelerates into the 40% zone, that triggers a warning that the S&P 500 SPX is at risk of stumbling over the next 12 months.

This next chart shows what has happened to the S&P 500's forward 12-month returns after the increased rate of margin borrowing has climbed into the 10th decile, where it stands currently.

The chart above suggests "you don't have to worry about margin debt until it starts to get out of control" in that 10th decile, according to Opsal. "Historically when investors are so aggressively borrowing, it has not turned out well," he said. "It's a behavioral issue."

After the stock market's top in 2021, the S&P 500 went on to plunge 19.4% in 2022, according to FactSet data.

Based on Leuthold's research, when margin growth has reached the highest decile relative to history, the S&P 500 has tallied an average 12-month drop of 0.5% on a forward basis. That's based on margin-debt growth averaging 50.5% in the 10th decile.

Worth watching

Individual borrowing on margin adds buying pressure in the stock market, said Mark Hackett, chief market strategist at Nationwide, in a phone interview Monday. "It's nerve-racking and worth watching," he said, with margin debt likely targeting areas of the market with momentum.

The borrowing was probably tied to areas like semiconductor stocks SOX, which have seen massive gains this year due to the artificial-intelligence buildout, Hackett said.

Check out: Why the stock market's red-hot momentum trade might be headed for a violent unwind this month

The use of leverage, whether from margin debt, options trading or levered exchange-traded funds, all tends to be concentrated in the same stocks, he said. Hackett cautioned that increased use of leverage targeting segments of the stock market can be a sign of "optimism that is bordering on a lottery mentality."

The U.S. stock market closed lower Monday, with the S&P 500, Dow Jones Industrial Average DJIA and the technology-heavy Nasdaq Composite Index COMP all falling as oil prices (CL00) climbed on renewed worries over heightened tensions between the U.S. and Iran. On Tuesday, investors will be watching closely as major Wall Street banks kick off earnings season for the second quarter.

-Christine Idzelis

This content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.

(END) Dow Jones Newswires

07-13-26 1819ET