The Independent Market Observer

11/21/13 – Margin Debt Versus Cash on the Sidelines

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Nov 21, 2013 4:51:46 AM

and tagged Ask Brad

Leave a comment

Bob Mestjian, one of our advisors and a fellow resident of Melrose, Massachusetts, wrote in with a very good question, to wit: “At the National Conference, you mentioned margin debit balances skyrocketing. However, I'm trying to reconcile skyrocketing margin debt with what I keep hearing about record levels of cash on the sidelines. Is there cash on the sidelines? Are there select investors who want to take risk ‘all in,’ using margin, while others are in cash and want nothing to do with stocks?”

Good question. First, let’s look at the concept of “cash on the sidelines.” This is a commonly used phrase, but unless the cash is actually stuffed in a mattress, it has to be somewhere in the financial system, where its removal—or relocation, really—would have effects. The phrase is usually a misnomer, as it reflects an investor preference for other asset classes over stocks.

There is some wiggle room on this at the moment, however, due to the large amounts of cash floating around the system thanks to our friends at the Federal Reserve. Even so, for retail investors, the notion of “cash on the sidelines” is misleading. For most of them, particularly in tax-deferred investment accounts such as 401(k)s, the cash is not on the sidelines but in bond funds of one sort or another.

In theory, then, reallocation from bonds to stocks by retail investors on a mass scale would drive interest rates up, with a negative effect on stock prices. This is not happening, due to Fed intervention and bond buying, even as retail investors do start to reallocate. But the idea shows how “money on the sidelines” isn’t actually just clean new buying power, as it will have other effects. The other component of the market is institutional investors, and here the notion of money on the sidelines is simply wrong, with most managers fully invested, according to most reports.

To bring this back to Bob’s question, there are two separate things going on here. One is the use of leverage by investors in the market, for a variety of reasons, and the other is the investment level of both retail and institutional investors. At our recent National Conference, I mentioned that margin debt was high by historical levels, which has nothing to do with how much equity investors have in the market. In fact, the margin debt is the disconnect between the two. You can have more equity and even more debt at the same time.

Here’s a housing example. For a town like Melrose, where Bob and I live, suppose everyone put down $20,000 on their house as a down payment, but that, as prices rose from $100,000 to $200,000 per house, they kept putting down that same $20,000. You would see the effective equity increasing in aggregate, even as it remained the same for each individual house; at the same time, the aggregate mortgage debt would rise. The comparison isn’t exact, of course, but this is one way to think of it. As prices rise, more borrowers are borrowing more to buy, even as the amount of equity remains the same or increases.

The answer, therefore, is that debt levels can rise even as investors commit more equity to the market—but that fuels an even larger increase in stock prices. It is just the fact that debt capital is more easily called away than equity capital that makes higher prices, supported by debt, more risky, which was the point I was trying to make.

Thanks, Bob!

Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics

New Call-to-action



see all



The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.


Please review our Terms of Use

Commonwealth Financial Network®