No Margin for Error

No cash…no worries.

There’s nothing quite like a booming market to bring a smile to banking executives.

Bankers will supply all the money that’s needed to meet demand. The fee revenue is too great to ignore…bonuses to be made and share options to be exercised.

We have such short memories.

The wisdom of the old saying ‘banks give you an umbrella when the sun is shining and take it away when it’s raining’ is forgotten when greed — by all parties in the transaction — is in the air.

When it comes to investing, there’s a well-recognised equation: the higher the market, the lower the investor IQ.

Never fails.

Proof of this proven formula is in the 11 December 2017 CNBC headline…

CNBC bitcoin headline

Source: CNBC
[Click to enlarge]

How dumb can people get?

Real dumb is the answer.

Here’s an extract from the article…

Bitcoin is in the “mania” phase, with some people even borrowing money to get in on the action, securities regulator Joseph Borg told CNBC on Monday.

“We’ve seen mortgages being taken out to buy bitcoin… People do credit cards, equity lines,” said Borg, president of the North American Securities Administrators Association, a voluntary organization devoted to investor protection. Borg is also director of the Alabama Securities Commission.

“This is not something a guy who’s making $100,000 a year, who’s got a mortgage and two kids in college ought to be invested in.”

The people with a mortgage, kids and modest income do not have spare cash to buy a ticket on the train headed to ‘easy money town’.

No cash…no worries. Borrow. Use your credit card. Take out some or all of that equity in your home (the equity you created from years and years of repayments).

What we’re witnessing is a severe case of ‘borrow in haste and repent in leisure’.

But it’s not just bitCON (sorry, bitcoin) that’s made people’s brains go to mush. The US share market has been on the up and up (courtesy of the Fed’s unwavering support) for nearly nine years.

The trend is now so mature that investors — by the market’s record setting feats — clearly believe ‘this time is different’. Those four fatal words have been the undoing of the gullible and the greedy throughout the ages…dating back to Tulip mania in 1637.

The following chart on margin lending in the US paints a clear picture of greed and fear going back to 1980.

The blue line is the S&P 500 index.

The red and green shaded areas are the amounts of negative (red) and positive (green) cash balances in margin loan accounts.

NYSE Investor Credit and the Market

Source: Advisor Perspectives
[Click to enlarge]

No surprise that at peak periods in the market — dotcom boom, US housing bubble and the Fed’s current bubble — the negative (more debt less cash) readings are also the highest.

People borrow at the top. After the markets crash, cash levels rise — people sell out at the bottom.

How’s that for dumb investing?

The pattern is as predictable as night following day.

Look at the level of negative credit balances as at December 2017…the highest on record.

Investors are going ‘all-in’ on an established trend…again

In Australia, we witnessed the same margin lending madness in the lead up to the 2008 market collapse.

Storm Financial and margin lending went together like fish and chips.

When the Aussie share market tanked more than 50% in value, Storm Financial clients lost their life savings and, in some cases, their homes. This was a preventable tragedy.

But in the midst of a boom, common sense always becomes a casualty.

The extent of margin debt in the US share market should be ringing alarm bells to anyone with even a shred of common sense and an understanding of history.

Alas, at this late stage in the market cycle, the voice of reason is more irritating than an overly excited Phyllis Diller.

In 2011, I wrote a book to my daughters titled A Parents Gift of Knowledge.

The purpose of the book was to provide them with a reference source. The following is an edited extract on the advice I gave them seven years ago. Lo and behold, nothing has changed.

Margin Lending

Unfortunately, most people take a margin loan (borrow to invest in shares) when the market is booming and when the inevitable bust comes they lose their money. 

I won’t bore you with the details of a margin loan, you can Google and research the workings of a margin loan online. 

Great wealth can be created if you borrow and the market rises and you actually take a profit by selling the shares. Some people get the borrowing and market rising bit right, but greed (hoping the market goes higher) or fear of paying capital gains tax on the profit stops them from selling and actually turning that paper profit into money (cash). 

There is a world of difference between saying “my shares have gone up in value $100,000” and saying “my shares went up $100,000 in value and I sold them and have the cash in the bank”. If you don’t believe me, try paying your grocery bill with unrealized share profits. I don’t think Woolies or Coles would be in that deal.

While great wealth can be achieved, the winners are usually a very small number of astute investors. Most people borrow to invest when the market is booming so they constitute a large chunk of the losers and the other losers are those that never take their profits. 

Unless you have a real passion for understanding the share market and possess an aptitude to identify when the market appears to be undervalued or over-valued, my advice would be to avoid a margin loan like the plague. The herd may be short-term winners, but I guarantee you they will be long-term losers. 

When the share market booms again (and believe me it will) I can absolutely 110% guarantee you that your friends, work colleagues, relatives or people you meet at dinner parties will be talking about how well their investments are doing and perhaps even telling you that margin lending is the greatest way to accelerate your wealth.

And here we are again in the midst of a boom.

BitCON is capturing the imagination (and eventually the dollars) of the millennials.

The US share market has temporarily suspended rational thought…people really believe one of the most expensive markets in history will never again revert to the mean.

There are very few certainties when it comes to life, but here’s one:

The higher that US markets go up, the more the red (negative) shading will become.

Now there’s a bet you should back with borrowed dollars. A guaranteed winner thanks to the predictability of human nature.

Central bankers have blown the greatest asset bubble in history — cryptos, property, shares and artwork. Everything but cash has floated higher on the creation of US$14 trillion in new money.

Lenders have never had it so easy. People are falling over themselves to get a slice of the action.

Sadly, it’s only when markets start falling over that investors find out just how slim the margin for error really was in the ‘borrow to invest’ strategy.

To learn how to create a buffer of security to protect you from the inevitable shattering of investor delusion, please go here.


Vern Gowdie,
Editor, The Gowdie Letter

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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