The U.S. stock market may soon experience a moment of "situational awareness."
At the very least, this is the worst-case scenario some Wall Street analysts are discussing. As they increasingly focus on a striking data point in the market: margin debt held by investors has reached an all-time high, and the recent rate of increase is only seen prior to major market corrections.
They fear that a sharp sell-off in tech stocks could ignite the fuse on this record-breaking loan, triggering margin calls and sparking a wave of forced selling that could disrupt the bull market.
Investors told Business Insider that while this scenario may sound unlikely, the risks are rising, and investors need to prepare—especially given the market’s heavy concentration in tech stocks and U.S. households’ significant exposure to sudden stock price declines.
Investors using margin trading can borrow money from their broker to buy stocks or investment products. However, if the value of their holdings falls below a certain threshold, they will receive a margin call requiring them to deposit additional funds into their margin account. If they fail to meet this requirement, the broker may sell their positions, potentially resulting in losses for the investor.
This is precisely what weighed on South Korea’s stock market this summer. Korean retail investors had high leverage, and when chip and memory stocks began to decline in the summer, they faced a wave of margin calls, triggering a chain reaction of forced selling.
The same dynamic led to a collapse in situational awareness. This was a highly leveraged hedge fund managed by AI newcomer Leopold Aschenbrenner, which received a margin call this summer after taking large positions in chip stocks.
According to FINRA data, debit balances in customer margin accounts for securities reached a record $1.5 trillion in June.
Although this level has slightly declined since the summer, it remains high. Margin debt in August stood at $1.4 trillion, representing a roughly 27% increase compared to the same period last year.
Peter Berezin, Chief Economist at BCA Research, told Business Insider that historically, a decline in margin debt from its highs has typically been a warning signal for the market. When margin debt begins to fall, it often indicates lower future stock returns. He added that if margin debt were to drop significantly from its summer peak, he would be concerned about a wave of deleveraging.
Once this begins, it often becomes self-reinforcing. As investors deleverage, they must reduce their equity exposure; this puts downward pressure on stock prices, triggering another wave of selling,” he said.
Berezin said investors today may be more vulnerable to such sell-offs than in the past. He noted that several concurrent vulnerabilities could make this scenario more dangerous:
- The market has a high concentration in technology stocks, which means that a deleveraging wave could be triggered within the technology sector and have an outsized impact on the broader market. Today, the information technology sector accounts for approximately 40% of the S&P 500 Index.
- Americans are more exposed to the sudden stock market decline than in the past, partly due to the large scale of household equity holdings. Federal Reserve data shows that U.S. households held a record $64.6 trillion in corporate stocks and mutual fund shares in the second quarter, accounting for more than one-third of total household wealth.
- Due to the proliferation of leveraged investment products in recent years, more investors have been exposed to leverage risk. A September survey by Yahoo Finance-Harris found that 43% of U.S. investors are using leverage in trading, such as trading options or buying stocks on margin. Bloomberg data shows that leveraged ETF assets also reached a peak of approximately $200 billion this summer.
“From this perspective, the risk in this stock market is even higher than it was in 2000,” said Berezin.
Ross Mayfield, Investment Strategist and Vice President at Baird Private Wealth Management, told Business Insider that record levels of margin debt suggest a rapid sell-off similar to what occurred in the Korean stock market this summer could also happen in the U.S.
“I do think the market structure may be a bit more fragile because we’ve introduced too much leverage into the market in various ways,” he said, but he also noted that this is not an existential threat to the market.
Measured by different metrics, current leverage levels appear extreme by historical standards. While margin debt as a percentage of total U.S. market capitalization remains close to the historical average of 2%, when measured against the M2 money supply, margin debt has reached levels comparable to those seen before the 2008 financial crisis and the dot-com bubble burst, according to a March analysis by financial services firm CGS International.
Ameriprise Financial's analysis found that since 1997, margin debt has grown at such a rapid year-over-year pace in only three years: 2000, 2007, and 2021—each of which preceded significant market corrections.
Ameriprise Chief Market Strategist Anthony Saglimbene described a scenario in which the record concentration of tech stocks collides with record leverage, ultimately triggering a "self-reinforcing" sell-off that hits the most concentrated stocks in the market.
He wrote in a memo: "When leveraged participants all hold the same underlying asset, and this trend is growing, upward or downward pressure can lead to greater market volatility that may not align with the developments in headline news."
Berezin said that if forced selling truly begins, investors have almost no obvious safe havens. He noted that the deleveraging during the dot-com bubble burst occurred in two phases: the first phase began in early 2000, as capital shifted from tech stocks to other sectors, allowing investors to find safety by moving to other parts of the market.
The second phase, beginning in 2001, was a broad market sell-off that affected all sectors.
Berezin said the market now appears to be entering a "rotation" phase, referring to the recent sell-off in chip and storage sectors. He speculated that a broader market sell-off similar to 2001 may still be years away.
It may still be too early to sound the alarm, but it’s not too early to start worrying if things get worse, because once they do, I believe it will become self-reinforcing,” he said.