Investor credit at Wall Street brokerages is falling by the most in a year as the Standard & Poor's 500 Index suffers its biggest losses since the bull market began.
Borrowed money in accounts at 61 New York Stock Exchange firms has fallen 4.6 percent, the biggest drop since June 2010, according to a July 22 statement from New York-based NYSE Euronext. The decline at NYSE firms followed a 36 percent increase to $320.7 billion in eight months, the biggest expansion since 2007. Leverage slipped to the lowest level of 2011 last week, according to Morgan Stanley's prime brokerage.
Lenders have been calling in loans since April, when the benchmark gauge for American equities began a plunge that has wiped out more than $2 trillion in value. While withdrawals preceded bear markets in the past and may worsen losses by leaving investors with less money to spend, they foreshadowed a return to the market by hedge funds and other speculators after the European credit crisis receded in August 2010.
"We cut leverage through the course of the year, keeping it as minimal as possible," Brian Jacobsen, who helps oversee $228 billion in 118 mutual funds as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin, said in an Aug. 12 telephone interview. "People tend to lever up in bull markets. When you look at risks in these markets, when there's more downside risk than upside in the short term, people don't want to amplify losses."
The S&P 500 has declined 12 percent from July 22 through Aug. 15, falling 6.7 percent on Aug. 8, its biggest drop since the 2008 crisis, as investors sold stocks from Bank of America Corp. (BAC) to Chemtura Corp. on signs the economy is faltering. The selloff deepened as S&P downgraded the U.S. government's long- term debt to AA+, conflicting with Moody's Investors Service and Fitch Ratings, which reaffirmed the highest rating on Treasuries.
Billionaire Warren Buffett said on Aug. 6 that the U.S. merits a "quadruple A" rating and the country isn't facing a double-dip recession. Treasuries gained last week, pushing 10- year yields down the most since 2008, after the Federal Reserve pledged to keep the target rate for overnight loans between banks close to zero through at least the middle of 2013.
Stock swings were among the widest on record last week, even though the S&P 500 only fell 1.7 percent. The Dow Jones Industrial Average alternated between gains and losses of more than 400 points for four days in a row, the longest streak ever. The S&P 500 closed as low as 1,119.46 on Aug. 8, within 29 points of a bear market, or a 20 percent drop. France, Italy, Spain and Belgium enacted bans on short selling or on short positions last week.
The S&P 500 rose 1.6 percent to 1,197.77 at 10:40 a.m. in New York today. The gauge closed at 1,178.81 last week.
Net hedge-fund leverage slumped to its lowest point this year at 49 percent of balances as of Aug. 10, according to an Aug. 12 note from Morgan Stanley's prime brokerage, which was sent to Bloomberg by a client of the bank who asked not to be identified for reasons of privacy. Last year, it reached its lowest point on Aug. 31 at 41 percent, data from the New York- based company show. Mary Claire Delaney, a spokeswoman for Morgan Stanley, declined to comment.
"It's all part of the avoidance-of-risk trade," Uri Landesman, who helps oversee $1 billion as managing general partner of New York-based hedge fund Platinum Partners LLP, said in a telephone interview Aug. 12. Landesman said leverage was reduced in his fund as the value of securities dropped. "People are dumping equities, emerging market equities, things seen as risk assets, and alongside with that we're seeing leverage being taken down."
Margin debt at NYSE firms peaked in July 2007 at $381.4 billion, a 41 percent increase from the level in November 2006. The S&P 500 reached its record high of 1,565.15 on Oct. 9, 2007, then tumbled 57 percent through March 2009. Margin debt climbed to its previous high of $278.5 billion in March 2000. The S&P 500 also peaked at a record that month before entering a bear market in which it lost 49 percent through October 2002, data compiled by Bloomberg show.
"The high this year was within two weeks of this number, so it does tell us something," Mike Shea, a managing partner and trader at Direct Access Partners LLC in New York, said in an Aug. 9 telephone interview. "Smart money started selling the market at its high and taking risk off the table, and the market chopped along a little more for June and July before following through to the downside."
Institutional investors expect leverage to decrease this year. Seventy-eight percent of investment managers said hedge funds will use "significantly less leverage now than prior to the 2008 credit crisis," up from 70 percent a year earlier, according to an April report by Rothstein Kass, a Roseland, New Jersey-based adviser to alternative investment companies.
To Laszlo Birinyi, president of Birinyi Associates Inc. in Westport, Connecticut, investor sentiment eroded because of the debate over raising the debt ceiling and the decline of the past 15 days has gone too far because earnings are still rising. S&P 500 profits may increase 17 percent to $99.24 a share in 2011 and 14 percent to $113.11 in 2012, analyst estimates show.11
"While this is painful to me, it's just a correction, it's being saturated by political circumstances and unfortunately political circumstances create emotion and emotion creates volatility," Birinyi, one of the first investors to recommend buying when the bull market began in March 2009, said in an Aug. 12 Bloomberg Television interview. "But I think the market situation is much more reminiscent of a 10 percent decline, not too dissimilar from what we had last May and June. I'm not of the belief that the bull market is over."