Postcards: On Margin Debt and Dog-Gifted Lotto Tickets

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[Subscribe here]() for more You are a free subscriber to Postcards from the Florida Republic. To upgrade to paid and receive the daily Republic Risk Letter, [subscribe here](. --------------------------------------------------------------- [Postcards: On Margin Debt and Dog-Gifted Lotto Tickets]( You have questions... Republic has answers.... [Garrett {NAME}]( Apr 13   [READ IN APP](   Dear Fellow Expat: A few months after our wedding, my wife and I moved to a shoebox apartment in the Chicago Loop. We lived in a great building with a pool we barely used, a gym we never visited, and a “dog walk” that needed company. By September 2015, we adopted a corgi-basset hound that we named Dagny. She was a spaz as a rescue, ripping up floors and eating yoga mats when left alone. After some work, she calmed down. Soon, Dagny became the toast of the town. When we bought our condo in North Center, we’d walk up and down the street at night. On the way back, under the Brown Line Addison, Dangy would glue herself to the door of a bar called “Cork Lounge.” She wouldn’t budge. She wanted to go in. You see, they gave her Slim Jims every time she came in. She always wanted her nightcap. Dagny met every bar, went to offices in the Loop, and lived a grand Chicago life. But it wasn’t until Florida - and a handful of short moves - that Dagny finally found her farm. Our vet diagnosed “Dags” with renal failure six years to the day that we took her home. She passed away three days later, with the wind kicking up just as the vet announced the time. Today - if you step onto this property and say her name - the wind does start to blow. My daughter is six now, and we have two new dogs. But Amelia remains certain that Dagny is always looking over her. Not long after Dags passed, my wife and I went to the beach. There, they found a bounty of sand dollars—even though my wife had never discovered one in her lifetime. “These must be from Dagny,” they both agreed. They took those shells and created a garden just outside our front door. They talked about how, even though Dagny had passed away, Amelia could still talk to her, and Dagny may come to visit in other forms. My father had cited the glimpse of cardinals as a visit from his father. I mentioned this to Amelia, forgetting I had done so. This child has remembered every conversation since she was three. The week we adopted Elsie, I had arranged a scavenger hunt for Amelia, who was two months from her fourth birthday. My daughter believed that Dagny arranged the scavenger hunt, and I didn’t really object. This hunt included a series of clues for her - boxes in the yard, down the road, at a miniature golf course, and ultimately, a Starbucks where there was a gift card for a PetSmart where we bought a new tag for Elsie (and Amelia named her). Inside some of those six boxes were coins, random things extracted from her room, and scratch-off lottery tickets - that my aunt had gifted me. A Starbucks employee made a snarky comment about “starting her gambling habit early” by having a $1 scratch-off ticket in the box. This woman didn’t like her job. I thought this would be the end of it. But shortly after her fourth birthday, Amelia stood by the Shell Garden holding Dagny’s collar, asking our dog to send her more clue boxes. This became a thing… where Amelia was sure that Dagny would leave her clue boxes (lottery tickets, maps, puzzles, and more). Maybe it all went too far, but our daughter believes Dagny is always with her. Last week, she saw a large yellow Butterfly while in the pool. “That’s Dagny, saying hello,” she said. So… does Amelia believe that her deceased dog brings her lottery tickets… put bluntly. Yes. It’s better than Scientology. On Debt, Leverage, and the System The other question I received was an analysis of margin debt in the financial system. Margin debt refers to funds borrowed by investors to buy stocks. People borrow money to buy stocks because they believe they can generate a higher return than the interest they’re paying on the capital. When funds and other investors are bullish about the stock market, they will take on debt to invest. But if they are bearish, they will pay off these debts and wind down the margin. In addition, many people who are lending money might feel that they could be better about the market's prospects, too, and will want their money back. So, they’ll demand that the borrowed money be returned to them. This is where a “margin call” comes into play. In this case, an investor's margin account (borrowed money) value falls below the broker's required minimum. If the value of these securities declines significantly, the investor must address the shortfall caused by the decrease in collateral value. The investor must deposit more funds or securities to meet the minimum equity requirement, or the broker may sell some of the securities held to restore the account balance. If this happens broadly in the aggregate, it can lead to a significant cascading effect. Margin calls can create forced selling or liquidation. Since borrowed capital is a staple of financial underpinnings, the impact of reduced margin on the stock market is not difficult to imagine. So, let’s turn to THREE charts to explain the recent runup on margin use during the last five months in the market. First, we start with the broader view dating back to the Dot-Com Bubble. StockMarketValuation.com has a simple chart that shows the use of margin and the standard deviations above or below its historical average. Right away, you’ll see that the use of margin - when it moves to the second standard deviation of the median (we’ll call this extreme use of margin debt) coincides with market tops of the Dot-Com Bubble, 2007, and, yes, the Post-COVID rally. The use of margin peaked in March 2021, just a month after Cathie Wood’s ARK Innovation Fund (ARKK) peaked. It is no coincidence that the bag of profitless “innovation” stocks peaked at this point—as did many “COVID” stocks, which have been down upwards of 70%, 80%, 90%, and more since that peak. But look at the other side of the equation—the points where the margin evaporates. Well, these are liquidity crises. After 9/11, the margin cycle bottoms out. Though the markets would continue to move lower, it wasn’t long before the Fed started to cut interest rates and boost system liquidity. I don’t need to explain the bottom of the non-use of margin in February 2009, when the credit systems were frozen after Lehman Brothers’ collapse. In March 2009, the financial markets received a jolt from the first round of Quantitative Easing by the Federal Reserve and a massive stimulus package filled with complete and total crap (the first big Pork giveaway in the post-Lehman era). And then… October 2022. This is the bottom of the recent liquidity cycle marked by the British GILT crisis. That month could have gotten worse if not for the coordinated efforts of multiple central banks. It took me a few months to realize what happened, but I quickly became VERY bullish in February 2023 after realizing just how much policy had changed in a matter of months from four major central banks: The Fed, the BoE, the BoJ, and the PBOC. This chart ends in December, but I assume we’ve moved back toward that first standard deviation band. I base it on this additional insight. FINRA provides ample analysis on margin debt, but its February 2024 chart offers perspective across the various periods we’ve assessed. We can see that gradual uptick off the bottom of late 2022. Increase liquidity, you’ll increase margin. Decrease liquidity… well… you know. That’s why we’ve been talking about tax season and its impact on bank reserves and the money market. You need collateral to get access to debt. Reducing your collateral by selling stocks or bonds to raise cash negatively affects things. Margin debt—the latest figures available—showed a gradual increase from the near-term bottom in October 2023. That was a period when the 10-year bond increased to 5%, which negatively impacted many of the collateral used to borrow money that would find itself allocated into the equity markets. What This All Means There are two things at play right now. First - money leaving the markets (likely for tax purposes) Second, bond prices fall, which impacts the value of collateral used for margin. Bond prices are falling due to rising yields linked to inflation concerns. When the market tanked into mid-June in April 2022, it accompanied a $600 billion drain from markets to Uncle Sam’s coffers. That’s what we’re waiting to see, but the recent negative Equity Signal comes on the back of this impact on reserves… and the spike in bond yields, which drive down the price of bonds. A reduction in the price of bonds impacts the collateral pool, which affects the total margin used. We knew there would be a drain in the money markets and the bank reserves. But the second part of the equation makes this week’s downturn dangerous. The government has to refinance a lot of debt. If interest rates continue to rise, this will impact that collateral pool. Bonds are commonly used as collateral to boost margins. And if those bond prices fall, the investor must pay more to cover costs. Looking ahead… the reserve issue should resolve itself in the next few weeks, and we should resume an uptick in liquidity. [Michael Howell noted in Capital Wars]( this week that his liquidity calculation hit another all-time high. And that is bullish for equities on the aggregate. Meanwhile, the issue of inflation is NOT resolved. While we were unsurprised by the three-month reversion in inflation figures, the markets again underestimated the “Higher for Longer” narrative. We take no pride in being right - and we wish that the Fed had pushed rates to 6% in early 2023 to flush out a lot of excess capital. The problem, however, is that the Fed can’t do everything - and Congress and this White House are running massive deficits and still providing ample stimulus to the economy from recent bills and new initiatives (yes, student debt forgiveness and commitments to “environmental justice” are stimulus by another name). We are facing a severe debt burden in 2025 - which will likely impact the financial system toward the end of next year. I argue investors need to get every dollar out of this market possible over the next 18 months and then prepare to close the shutters and play defense on the backend of this financial cycle. We are keeping our focus on the 1970s playbook - and can’t help but notice that Goldman Sachs and other banks are providing similar insights now that they’ve realized the Fed’s war against inflation is failing. Stay positive, Garrett {NAME} Disclaimer Nothing in this email should be considered personalized financial advice. While we may answer your general customer questions, we are not licensed under securities laws to guide your investment situation. Do not consider any communication between you and Florida Republic employees as financial advice. Under company rules, editors and writers cannot recommend their positions. The communication in this letter is for information and educational purposes unless otherwise strictly worded as a recommendation. Model portfolios are tracked to showcase a variety of academic, fundamental, and technical tools, and insight is provided to help readers gain knowledge and experience. Readers should not trade if they cannot handle a loss and should not trade more than they can afford to lose. There are large amounts of risk in the equity markets. Consider consulting with a professional before making decisions with your money.   [Like]( [Comment]( [Restack](   © 2024 Garrett {NAME} 548 Market Street PMB 72296, San Francisco, CA 94104 [Unsubscribe]() [Get the app]( writing]()